Home »Stocks and Bonds » Pakistan » Sensible thinking at SBP

Why has the central bank not slashed the interest rate given the average inflation is down to below 8.65 percent and is probably going to remain low? Well, the message conveyed from the State Bank is sensible: you cannot rely on manna from heaven without improving the macroeconomic fundamentals and resolving structural impediments.

The $1.5 billion from one friendly country is meant for fiscal financing and is cancelled out by less borrowing from the banking system. There is no creation of money in the economy as overall monetary aggregates remain the same: the NFA increase is cancelled out by the decline in NDA. However, it improves the NFA-to-NDA ratio which would help in slashing the inflation in the medium term.

IMF's review is due in a week's time and the government is seeking couple of waivers on targets like zero net borrowing from the SBP. The SBP has shown government borrowing at Rs2,669 billion as of March 7 in the latest monetary policy. That implies that the year-to-date borrowing stands at Rs457 billion. In order to meet (or come close to meeting) the IMF's net zero quarterly borrowing target, the government ought to go to the market to plug the deficit.

On the flipside, banks don't have appetite at lower rates, so it's imperative to keep real interest rates positive to keep on enticing banks' treasuries into the business of government borrowing.

This is evident from the fact that lately, government has been raising funds from banks through longer-term papers at higher rates. Government has raised Rs449 billion in PIBs in the last two auctions at rates above 12 percent. This 3-4 percent real return on a government paper over inflation is clearly depicting that the market does not have appetite at prevailing discount rates.

If the policy rate comes down, then the PIBs rate can come down, too. But then the government's desired twin shifts - a) moving its financing from SBP to commercial banks and b) increasing banks' reliance on long-term papers - wouldn't be possible by lowering interest rates right now.

Then there is not much liquidity in the market. That is evident by the injection of close to Rs400 billion in last couple of weeks. Any cut in the interest rate may exacerbate the liquidity situation.

Then the other sensible reason for not easing the monetary stance is to bring stability in the currency appreciation. It's not Finance minister Ishaq Dar's self-fulfilling prophecy to revert the rupee-dollar parity at 98 and keep it there for considerable period of time. The very next day after it hit 98, the rupee started sliding down, and in the open market, it has already crossed the century mark.

By keeping real interest rates positive for some time, there is a good incentive for capital to flow in by virtue of both foreign investment and home remittances.

Once the inflation actually comes down to 7 percent and its rational expectations are lower, then the government can conveniently ease the monetary policy by lowering the rate. It can also raise financing from banks at lower rates, with less chance for currency to slip at lower rates. As of now, the market probably does not trust the government's inflation numbers and wants some premium over the official numbers.

A simple calculation shows that if electricity price hike is passed on to non-lifeline consumers, inflation would increase by at least three percentage points to reach 11-12 percent. Interestingly, banks are financing the government, on average, more and less at this rate lately. Then higher utility prices are also keeping inflationary expectations high.

Government can change the perception by passing on the appreciation of rupee against dollar by lowering electricity and petroleum prices considerably. Once that happens, rational expectations will be low and there would be ample room for running an easing monetary policy!

Copyright Business Recorder, 2014


the author

Top
Close
Close