WEB DESK: As anticipated by this newspaper, the State Bank decided to keep the policy rate unchanged at 6 percent over the next two months.
According to Monetary Policy Statement (MPS) released on 21st November, 2015, the main reason for maintaining the status-quo is the expectation of a reversal in the declining momentum of headline inflation.
The average July-October inflation at 1.7 percent this year was much lower than 7.1 percent recorded in the same period last year. With a subdued outlook of international commodity prices including oil and in the absence of any shock to supply of food items, the average inflation was likely to remain below the FY16 target of 6 percent but the present trend of a sharp decline in the inflation rate was expected to reverse in the coming months.
Current account deficit had narrowed down to dollar 532 million during July-October, 2015 compared to dollar 1.9 billion in the corresponding period last year due to a substantial reduction in the oil import payments, healthy workers’ remittances and the realisation of Coalition Support Fund (CSF).
At the back of official disbursements and Eurobond inflows, surplus in capital account had supported the overall balance of payments position thus ensuring an upward trajectory in foreign exchange reserves. While realisation of investment inflows from the CPEC would strengthen the external sector outlook over the medium to long-term, continued flow of external resources was required to maintain a stable balance of payments position.
Large-Scale Manufacturing (LSM) had increased by 3.9 percent during July-September, 2015 as compared to 2.6 percent in the first quarter of previous year. A further boost to this growth was expected from expansion in cotton yarn manufacturing, strong construction activities, increased automobile production and improvement in energy supply at the back of LNG imports.
Credit to private sector witnessed a nominal increase in July-October, 2015. The weighted average lending rates on fresh and outstanding loans at 7.8 percent and 9.2 percent in September, 2015 were the lowest in 10 years. With the current credit cycle now entering in uptake phase and improving LSM growth, bank borrowings, both for working capital and fixed investment, are likely to increase which would reflect in broad money (M2) growth.
So far, while Net Domestic Assets (NDA) had declined by Rs 78 billion, contribution of Net Foreign Assets (NFA) to M2 growth remained substantial at Rs 106 billion.
Though the business community, in general, was advocating a further rate cut of 0.5 percent for lowering their cost of production, sticking to the present monetary stance, in our view, was a better option which the State Bank did not hesitate to exercise. A substantial reduction in the policy rate in the past was possible due to a steep fall in the rate of inflation – a trend which is not likely to persist in the coming months.
Commodity prices in the international market, including that of oil, are not expected to decline at a fast rate recorded in the recent past. This together with the base effect, increase in gas prices, depreciation of the rupee and the likelihood of expansion in broad money caused by the increase in private sector credit during the remaining part of the year were expected to increase the rate of inflation though it would be still below the target of FY16 target of 6 percent.
It is clear that the State Bank has preferred to maintain the existing policy rate due to the expectations of some increase in the inflation rate. Such a policy would also allow the SBP to “wait and see” before making the next move. Obviously, if the inflation rate continues to persist at the present level, SBP may be constrained to cut the policy rate further in the coming months.
Another factor which could have prompted the State Bank not to make another cut in the policy rate was the rapid depreciation of Pak rupee of about 5 percent in the recent past. A reduction in the deposit rate on rupee holdings would have provided an incentive to savers to shift their rupee balances into dollar-denominated assets, thus quickening the rate of depreciation of rupee and dollarisation of the economy.
Shifting of savings abroad would have been even worse due to a negative impact on the domestic rate of investment. Such a negative trend would accelerate further if the US central bank was to increase the interest rate in December, 2015. A contraction of over 10 percent in exports was another bad news that seems to have forced the SBP to play it safe.
While the decision to maintain the policy rate at the existing level of 6 percent is justified, State Bank’s overall attitude towards government, of late, appears to be highly accommodating. For instance, although monetary policy of the country has become almost hostage to fiscal imperatives, yet, unlike the past, there is no mention of the shortfall in tax revenues, the size of budget deficit and the measures needed to improve the fiscal position.
Also, interest rates on counter finance facilities are being dictated from Islamabad and the State Bank continues to follow these dictates faithfully. Only a couple of days ago, Finance Minister Ishaq Dar, while addressing the business community in Karachi, said the State Bank had been asked to make SME financing mandatory for banks to facilitate and promote one of largest sectors of the economy. Obviously, such a dictation is against the autonomous status of the central bank and needs to be resisted by the Board of the State Bank.
According to the laws of the land, monetary and credit policies are to be formulated by the Board of the State Bank (Monetary Policy Committee under the new SBP (Amendment) Act, 2015) without any interference from outside. Government could of course recommend but cannot direct the State Bank of Pakistan to follow a certain line of action suitable to the government’s needs.
Market intervention after the Lehman Brothers crisis may be the new norm. However, credit growth has not materialised despite a 400 percent reduction in rate. The Central Board of Directors of SBP appears to be hesitant to share their views with the market. Communication by a central bank on its future outlook has become important.
Let us hope that the MPC as an independent monetary policymaking forum would act otherwise, and issue a proper narrative that explains the decision-making process. It is also expected to divulge the minutes of its deliberations with a time lag. Without this, it would be business as usual.