* Containing inflationary pressure major objective of monetary policy
* Current account deficit expected to widen during FY11
State Bank of Pakistan (SBP) reforms are aimed at phasing out role of institutional investors in National Saving Schemes, review of the Export Finance Scheme (EFS) and Long-Term Financing Facility (LTFF), so as to ensure removal of distortions by narrowing the difference of interest rates on subsidised schemes with the market interest rates and making them more focused to achieve objectives for which they are created.
According to a presentation of the SBP made at Pakistan Development Forum (PDF), objective (s) of the SBP’s monetary policy is to strike a delicate balance on inflation containment and maintaining supporting economic growth.
Recent experiences with monetary management — inflation: After a sustained reduction, from 20.8 percent in FY09 to 11.7 percent in FY10, inflation has started to increase again in FY11, September & October in excess of 15.4% YoY
Most of this inflation is being contributed by food, fuel and transportation groups after floods. The resurgence in inflation can be attributed to a number of factors. Reform measures (to dismantle past distortion/suppression of energy and oil prices) whose impact is being felt in the short-term and reduction in energy related subsidies.
External: Increase in international commodity prices such as those of edible oil, wheat, rice, corn, etc.
Domestic: Food inflation (prices of perishables increased by 48 percent during Aug-Sep 10 and have declined by only 6.7 percentage points in October) after floods (supply chain issues) due to the crop losses, damage to communication infrastructure, increase in transportation costs.
To contain inflationary pressures, SBP has raised the policy rate twice since the beginning of FY11 (in July and September 2010), by 50 bps each.
In FY10 the external current account deficit (CAD) had improved following some reduction in international commodity prices relative to their FY08 levels and demand management policies, including a tight monetary policy.
However CAD is expected to widen during FY11 with import growth projected to accelerate with increase in exports expected to remain soft in view of weak growth prospects globally.
Removal of SBP support for oil payments: Increased flexibility in exchange rate movement with minimal SBP interventions, separation of liquidity and debt management, transfer of decision on amount to be raised in T-bill auctions and the cut-off rate to the MoF has removed ambiguities — enhancing the role of SBP’s policy rate as the sole instrument for signaling monetary policy changes. Advance announcement of a T-bill auction calendar by the Ministry of Finance (MoF). This has reduced uncertainty and improved liquidity forecasting and management.
Establishment of Monetary Policy Committee (MPC): A 9-member MPC is chaired by Governor SBP with two external academic experts.
Minutes of MPC meetings along with votes of members (without names) on monetary policy decisions have been posted on SBP’s website that discuss increasing transparency of monetary policy formulation process and SBPs credibility.
Frequency of monetary policy reviews and decisions has been increased. Instead of twice a year, SBP now announces its monetary policy decisions six times a year.
Challenges in the form of government borrowing: Apart from causing inflation, unrestricted access of GoP to borrowing from SBP complicates liquidity management, dilutes the impact of the monetary policy stance, puts pressure on the exchange rate and hurts the private sector by affecting availability and cost of credit.
Total government borrowings 50% of NDA of banking system (56% If PSEs included) high and at rising rates of interest because of borrowing of Rs 390 billion for trade in commodities like wheat, sugar, rice, fertiliser etc.
Reforms undertaken: MoF has piloted an amended SBP Act through the National Assembly. That limits government borrowing from SBP to only 10% of previous year’s revenues and link it to FRDL. Government is also bound to gradually reduce its current stock of borrowing from SBP (Rs 1355 billion or 65% of revenue) in the next 5 years – which will enhance autonomy of SBP.
Challenges: Different components of credit affected by interest rate changes with different intensities. Understanding of other channels through which monetary policy influences economic behavior needs improvement. Despite weaknesses, monetary policy remains effective in controlling inflation, reflected also in the decline of core inflation.
Large banking spreads and credit concentration challenges: Large spreads between interest rates on deposits and interest rates on loans (700 basis points) partly due to limited saving avenues and heavy reliance of borrowers (government, private and public sector) on banks to finance their needs. The weighted average returns on deposits are low because most of the deposits are in zero return current accounts (26%) and 5%minimum return saving accounts (38%). Presence of large informal sector is also contributing to transmission weaknesses.
Planned reforms: Widening access to government paper, creating greater awareness on high-return term deposits, development of a market for corporate debt, phasing out role of institutional investors in National Saving Schemes.
Subsidised credit facilities challenges: Facilities like Export Finance Scheme (EFS) and Long-Term Financing Facility (LTFF), complicate monetary management (their effects are similar to printing money) and promote economic inefficiency. Efforts of banks to mobilize deposits and raise returns constrained by easy availability of re-finance from SBP. These schemes also dilute the clarity of the main objectives of SBP, which hare price and financial stability.
Reforms undertaken: Removal of distortions by narrowing the difference of interest rates on subsidised schemes with the market interest rates and making them more focused to achieve objectives for which they are created.
Several in-house studies are in progress to limit inflationary impact of refinancing by enhancing focus on development finance and improve functioning of credit markets e.g. reforming EFS to consider focus on SME and non-traditional exports, developing incentive packages for agriculture, microfinance and SME by experimenting in flood affected areas.
Coordination between monetary and fiscal policies challenges: Increased coordination between monetary and fiscal policies are required to achieve mutual and desirable macroeconomic goals through sharing of data and information and regular interaction at the technical and policy level to ensure consistency between monetary and fiscal policies.
Source: Daily Times, 21-NOV-10