The year-on-year CPI inflation for November, 2012 stood at only 6.9 percent, with food inflation dropping to 5.3 percent and non-food inflation coming down to 8.1 percent. Even the core inflation was in a single digit. This broad-based deceleration in inflation was expected to keep the average inflation for FY13 below the 9.5 percent target for the year.
Although, low level of bank credit extended to the private sector and a small current account deficit in October, 2012 were also cited as "fundamental variables" influencing the easing of monetary policy, it becomes quite clear from a closer examination of the MPS that the behaviour of these factors was not very relevant to the case and the State Bank was just trying to find some other reasons to back up its stance. Such a conclusion could easily be drawn because while analysing the sectoral situation thoroughly in the later part of its assessment, the State Bank seems to be deeply concerned about the trends in the external sector of the economy and does not find a proper relationship between a reduction in the policy rate and expansion in credit to the private sector because of certain constraints. The State Bank also continues to be extremely concerned with the fiscal situation of the country and its constant pressure on monetary policy formulation.
There is no doubt that most of the observations and analyses of the State Bank in its latest MPS are backed by data. Though the rate of inflation as measured by the trends in CPI has slowed down, the latest developments in external sector accounts and fiscal position continue to be major source of concern. It is almost certain that Pakistan would find it extremely difficult, if not altogether impossible, to pay heavy instalments to the IMF for the previous SBA. This could force the country to negotiate another arrangement with the Fund with very harsh upfront conditionalities. In any case, rupee was bound to depreciate further, inflation rate could accelerate and foreign exchange reserves held with the SBP could fall to dangerously low levels.
The State Bank has rightly identified substantial debt repayments to the IMF and declining net capital and financial inflows as the main sources of instability in the foreign sector but unfortunately the country has to live with these factors for some time and try simultaneously to maintain the solvency of the country at all costs. The Finance Minister, realising the gravity of the situation, appears to be striving to negotiate some kind of arrangement with the IMF but the clinching of a deal in the next couple of months seems impossible due to the indifferent attitude of the political leadership and a very short tenure of the present dispensation. The situation on the fiscal front was equally complex and disturbing. The task of containing the size of fiscal deficit and government's borrowing requirements from the banking system is becoming more and more difficult.
Most depressing is the fact that federal and provincial governments are least bothered about this highly undesirable development and making no efforts to reverse this unsustainable situation. Driven primarily by excessive budgetary borrowings from the banking system, the year-on-year growth in broad money was 17.8 percent as against a GDP growth rate of less than four percent, leaving a large room for inflationary pressures to emerge in the next few months. As if this was not enough, State Bank is not even sure now about the expansion of private sector credit and revival of investment and growth as a consequence of reduction in the interest rates which used to be its main argument to make a downward adjustment in the policy rate in the past. The data during the past 16 months has clearly disproved such a relationship due to a pervasive impact of other factors like energy shortages and poor law and order situation on the demand for credit.
Given the complexity of the present situation and the weakening of standard linkages between various policy tools and their outcomes, it is the duty of the State Bank to clearly prioritise its thrust for monetary policy formulation among a host of competing considerations. While easing of inflationary pressures definitely suggested a reduction in the policy rate, almost all other factors including increasing stress on the external sector and widening fiscal deficit necessitating larger recourse to bank borrowings and leading to excessive money supply have underscored the need for toughening or at least maintaining the current flexible monetary policy stance. Assigning appropriate weightages to all the competing considerations of course is a huge challenge for any monetary authority. But this is where the depth of a central bank is tested.
The business community is more concerned at the fast depreciation of rupee and fears that falling forex reserves could lead to import controls. SBP may not be able to do much about the violation of Fiscal and Debt Limitation Act by the federal government without Parliamentary support. But they should not in the present circumstances remove the six percent floor on bank deposits. This minimum return on deposits in Islamic banks has been removed. If it does so, the effectiveness of its interest rate corridor would be diluted and liquidity management would become even more difficult. Repeated failure of fiscal authorities to forecast forex inflows, in fact, needed a more wait and see attitude - by keeping SBP policy rate unchanged. SBP's depleted Central Board of Directors has taken a gamble that any further rupee depreciation would earn more in taxes and could reduce imports. But our imports are, by and large, inflexible. Let us pray that international oil prices go down further and some external help by way of dollar inflows materialises before the IMF releases a tranche to help us service our external debt in order to protect and preserve our solvency.