|SBP Keeps Discount
by SHABBIR H. KAZMI
The State Bank of Pakistan decided not to further cut the discount rate despite growing demand of the trade and industry. The decision has attracted mixed reaction but the overall consensus is that under the prevailing conditions and emerging scenario the central bank had little options. In fact there are growing fears that the reversal of trend seems inevitable. These analysts go to the extent of saying that the way economy is performing, very soon Pakistan will have to enter into another standby assistance program with the International Monetary Fund (IMF).
As against this, some analysts still insist that reduction in interest rate is necessary to spur growth and ease debt servicing pressure on government. Their opponents say that reduction in interest rate alone can't usher new investment. They insist that higher interest rate is not discouraging creation of new manufacturing facilities but prolonged outages of electricity and gas has virtually brought the productive process at grinding halt. It is on record that closure of CNG stations alone on November 29 created havoc in Karachi due to non-availability of public transport. Earlier energy related riots were witnessed throughout the country.
Before criticizing the SBP decision it is also necessary to examine the reasons put forward in support of its decision. These include 1) inflation remaining a serious issue, 2) the current account deficit hovering around US$1.6 billion during first four months of the current year, higher than earlier projected full-year deficit and 3) reserve depleting at faster rate due to rising imports and no 'other inflows'. Add to this the IMF debt servicing which would become due early 2012. Therefore, the decision looks prudent, though may not bode well in ushering economic growth in the country.
Inflation rate in the country is likely to remain high due to increase in wheat support price, electricity and gas tariffs and depreciating rupee, already down by more than two per cent since commencement of the current financial year. The added fear is hike in crude oil price due to rising tension between Iran and the west, especially after expelling of diplomats by Iran and Britain.
It has been pointed out repeatedly that reduction in interest rate alone can't boost GDP growth rate unless energy crisis is resolved. There are growing apprehensions that the groups having vested interest want energy crisis to continue and Pakistan's oil import bill to remain high. They insist that energy crisis is the outcome of gross mismanagement rather than demand exceeding supply. Therefore, need of the hour is to make the best possible use of available domestic resources.
The SBP believes that macroeconomic risks have increased since October with inflation remaining high and rupee coming under renewed pressure. According to the SBP, inflation will accelerate in 2012. There is also a risk that the government will resort to printing money to finance its large deficit as markets demand higher premiums on Treasury Bills and Pakistan Investment Bonds.
The growth outlook remains weak and the IMF projects 3.5% YoY growth for FY12, lower than the government target of 4.2%. The key concern is the slowdown in export growth owing to a decline in cotton prices and weak credit growth. This is primarily because of heavy government borrowing from banks, leading to a crowding out of the private sector. Private-sector investment spending declined to 8.5% of GDP in FY11 (year ending 30 June 2011), from 15% in FY08, mainly due to energy crisis and political and security concerns. After posting record export growth of 29% YoY in FY11, Pakistan's export growth fell to 8% in October this year, mainly due to a decline in cotton prices and the weak global economy. Experts fear that export receipts may decline to around US$24 billion from US$25.4 billion in FY11. Therefore, the SBP will have to balance inflation risks against weak growth outlook.
Another key factor adding to inflation fears is massive import of fertilizer because the government has to pay huge subsidy on imported urea. The numbers become mind boggling because on each ton of urea imported, the government has to pay around Rs35,000. The government has asked the Trading Corporation of Pakistan to arrange import of 0.7 million tons urea. Out of this 0.4 million tons has already arrived and remaining will reach before end December this year.
It is evident how base effect from last year's hampered tax collection owing to flood may have resulted in improving performance. It is believed that revenue measures taken in the budget may be yielding result. Both direct and indirect taxes are showing reasonable improvement, with sales tax registering growth of 35%YoY in absolute terms. However, in real terms tax collection still stays at 1.9% of GDP compared to 1.8% last year, while direct tax-GDP also shows improvement, though marginal.
It is evident that real growth in taxes is still lacking and only a handful of sectors can be seen outperforming (in terms of volumetric growth and credit expansion). Another notable shift was seen in the federal and provincial fiscal balances, where federal deficit dropped in favor of a lower provincial surplus. This suggests that the NFC Award is finally yielding some results, where burden of expenditures is being shifted to provinces.
A more serious aspect of the fiscal deficit is the way it is financed. With net retirement of Rs4 billion from external side, the entire deficit during first quarter was financed through domestic sources. However, this does not come as surprise since FY12 budget had already envisioned deficit being financed heavily through domestic sources. Therefore, what should be more concerning is a higher-than-targeted deficit (impact of circular debt swap) and non materialization of fresh external flows, which could have sufficient consequences on domestic liquidity and, in turn, interest rates and inflation, with growth still difficult to read anywhere in between.