The Central
Board of Directors of the State Bank of Pakistan
at
its meeting held under the
Chairmanship of SBP Governor, Mr. Yaseen Anwar in Karachi
today has decided to keep the policy rate unchanged
at 12 percent after thoroughly
considering the need to revive growth and emerging risks to
macroeconomic stability.
‘To promote
competition in the banking system
and to offer alternative sources of savings to the population, SBP has been encouraging depositors to invest in government securities through Investor’s Portfolio Securities (IPS) accounts,’ the State Bank of Pakistan
said in its
Monetary Policy
Decision.
It said the option of maintaining saving deposits or investments in IPS accounts could provide
stiff competition to banks
forcing
them
to
offer
better
returns
on deposits. ‘This in turn
would
incentivize savings and help lower the currency in circulation,’ it added.
Moreover, it will improve the transmission of monetary policy changes to market interest
rates,
SBP’s Monetary Policy
Decision said, adding
that
over
time this strategy would also
diversify the government’s funding source, deepen the secondary market
of government securities, and facilitate the issuance of corporate debt.
Following is the complete text of the Monetary Policy Decision:
“The SBP reduced its policy rate by 200 bps, to 12 percent, in FY12 so far. The objective of adopting this stance is to support revival of private investment in the economy despite a constraining domestic and global economic environment.
The primary factors
in support of this stance were the expectation of
average
CPI inflation remaining within
the
announced
target in FY12
and
a
small
projected external current account
deficit. In pursuing this stance SBP did acknowledge the risks to macroeconomic stability emanating from fiscal weaknesses and falling foreign financial inflows.
These include resurgence of medium term inflationary pressures and challenges SBP is facing in managing market
liquidity and preserving foreign exchange reserves.
A reassessment of latest developments and projections indicate that macroeconomic risks have somewhat increased during the last two months. For instance,
although the year‐on‐year
CPI
inflation stands at 11 percent in October 2011, the month‐on‐month
inflation trends, averaging
at around 1.3 percent per month during the first four months of FY12, show existence
of inflationary pressures. The sifting of commodity
level CPI data reveal that the number of CPI items exhibiting year‐on‐year inflation
of
more than 10 percent is consistently
increasing and almost all of these items belong to the non‐food category. The government has also increased
its wheat support
price by Rs100 to Rs1050 per 40kg for
the next wheat procurement season.
Thus, while the average
inflation may settle around the
targeted 12 percent for FY12, it is
uncertain that inflation
will come down to a single digit level in FY13. The main determinants
of this
inflation behaviour are government borrowing from the banking system and inertial effects of high
inflation on
its expected path. The severe
energy shortages are also holding
back the effective utilization of productive capacity and adding
to the high inflation‐weak
growth problem.
On the external front, the earlier comfortable
external current account position for FY12, which
helped SBP in lowering
its policy rate, has become less benign. The actual external current account deficit of $1.6 billion
for the first four months of FY12 is now higher
than the earlier
projected deficit for the year. The main reason for this larger than expected deterioration
is the rising trade deficit. In particular,
the
windfall gains to export receipts due to abnormally high
cotton prices in FY11 have
dissipated faster than anticipated. This
is indicated by slightly less than $2 billion per month export receipts in September
and October 2011. At the same time, international oil prices of around $110 per barrel
and strong growth in non‐oil
imports have kept the total import growth at an elevated
level of close to $3.4 billion per month. Adding to the challenges faced by the external sector is the precarious global economic outlook.
A relatively larger external
current account deficit in FY12 would require higher
financial inflows to maintain foreign exchange reserves. However,
during July‐October, FY12, the total net direct and
portfolio inflows were only $207 million
while there was a net outflow of $113 million
in official loans. As
a consequence, SBP’s liquid foreign
exchange reserves have declined to $13.3 billion at end‐October
2011 compared to $14.8 billion
at end‐June 2011.
Given the scheduled increase in repayments of
outstanding loans
in
H2‐FY12, realization of substantial foreign flows, especially the
proceeds
of assumed
privatization receipts, euro bond, Coalition Support Funds, and 3G licence fees, becomes important for strengthening the external position.
A reflection of widening external
current account deficit and declining financial
inflows can be seen in the reduction of Rs115 billion in the Net Foreign Assets (NFA) of SBP’s balance sheet during 1
July – 18 November, 2011. This implies that to meet the economy’s
prevailing demand for money, SBP has
to provide substantial liquidity in the system, at least to the extent of compensating
for the declining NFA of SBP. As of 28 November
2011, the outstanding amount
of liquidity injected by SBP through
its Open Market Operations (OMOs) is Rs340 billion.
This
is significantly higher than normal SBP operations and appears to have developed characteristics of a permanent nature at this point in time.
A dominant source of demand for money and thus liquidity injections
by SBP is government borrowings for budgetary support
from the banking system. Excluding the issuance of government securities of Rs391 billion to settle
the
circular
debt
and
commodity loans, the government
has borrowed Rs255 billion from scheduled banks and Rs62 billion from SBP during 1 July – 18 November,
2011 to finance its
current year’s budget deficit.
The growth in private sector
credit has remained muted so far but may pick up in coming months as the desired effects of a cumulative decrease
of 200 bps in the policy rate and reduction in financial constraints of the energy sector
gather momentum.
In this context where government is the main user of the system’s liquidity and banks remain hesitant to extend credit to the private sector, SBP faces a dilemma.
Efforts to scale down liquidity
injections could have implications
for settlement of payments in the interbank market, which is an
important consideration given SBP’s mandate of maintaining financial
stability. Even if these considerations are addressed, the government may end up settling
its obligations by borrowing from SBP.
This does not bode well for government’s own commitment of keeping such borrowings at zero on quarterly basis. The marginally increasing trend of these injections, on the other hand, also carries inflationary risk, which is not consistent with the objective of achieving and maintaining price stability.
There are three solutions
to this predicament of reconciling price and financial
stability considerations and supporting private
investment in the economy. First,
the government needs to ensure that all or major parts of budgeted
foreign inflows materialize as soon as possible. This will alleviate pressure on the balance
of payments and help inject fresh rupee liquidity in the system.
Second, sooner than later the government
will
have
to
initiate
comprehensive tax reforms that broadens the tax base of the economy. This is of paramount importance to reduce the government’s borrowing requirements from the scheduled banks that are currently not consistent with the objective
of promoting
private sector and economic growth. Third, efforts need to be stepped up to improve financial deepening and increase competition in the banking
system.
The last of these solutions is something
that SBP has been actively
working on. For instance, to
promote competition
in the banking system and to offer alternative sources of savings to the population, SBP has been encouraging depositors to invest in government securities through Investor’s Portfolio Securities
(IPS) accounts. The option of maintaining
saving deposits or investments
in IPS accounts could provide stiff competition to banks forcing them to offer better returns on deposits. This
in turn would incentivize savings and help lower the currency in circulation. Moreover, it will improve
the transmission of monetary policy changes to
market interest rates. Over time this strategy would also
diversify the government’s funding source, deepen the secondary
market of government securities, and facilitate the issuance
of corporate debt.
Finally, it must be understood that there are uncertainties involved in realizing the full benefits of these measures. These uncertainties can potentially have adverse effects on SBP’s recent efforts
to support private sector credit and investment in the economy. Therefore, after giving due consideration to the need to revive growth and emerging
risks to macroeconomic stability, the Central Board of Directors of SBP has decided to keep the policy rate unchanged at 12 percent.”
