Monetary Policy of Pakistan for Fiscal Year 12

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MONETARY POLICY OF PAKISTAN 2012

The basic challenge faced by Pakistan’s economy is financing its fiscal and external current account deficits. The size of these deficits may not be considered large given the current state of falling private sector investment demand in the economy. A reflection of overall low aggregate demand can be seen in the declining inflation trend, contraction in the real private sector credit, and falling volume of imports. The SBP’s monetary policy stance in FY12 so far, a cumulative reduction of 200 basis points, has been largely framed in this context.

The lack of diversified and sustainable financing sources has resulted in substantial borrowings from the banking system by the government and declining foreign exchange reserves. This has squeezed the availability of credit for the private sector and increased the pressure on rupee liquidity. The SBP has been providing substantial liquidity on almost permanent basis, on average Rs230 billion during 1st July – 9th February 2012, to ensure smooth functioning of the payment system and avoid financial instability. The continuation of this trend, however, carries risks for effectively anchoring inflation expectations in the medium term.

A declining interest rate environment together with a relatively better growth in Large‐scale Manufacturing (LSM) is expected to help the pickup in private sector credit. The LSM sector grew by 1.5 percent during July‐November, FY12, which is in contrast to an average contraction of 3.1 percent during the same period of last three years. Moreover, credit to the private sector has expanded by Rs238 billion during 1st July – 3rd February, FY12. However, to assess its likely path few points need to be kept in mind.

First, given the continuing energy shortages, unfavourable law and order conditions, and an uncertain political environment, the desired boost in business confidence and thus private sector credit may not take place. Second, profitability of the textile sector, a major user of private sector credit, was better in FY11 due to higher cotton prices. This would facilitate repayments or keep the demand for fresh credit to a minimum in FY12. Third, the utilization of installed industrial capacity is considerably low and continues to decline, which is inhibiting credit demand for fixed investment. Fourth, all of the fresh credit disbursement in H1‐FY12 was utilized to meet the working capital requirements, which implies that a significant part of this credit will be retired in H2‐FY12.

Thus, the full year expansion in credit to the private sector is expected to remain weak for yet another year in FY12 despite interest rate reductions. Its year‐on‐year growth is already negative in real terms and indicates depressed private investment demand in the economy. In addition, given substantial government borrowings from the 2 scheduled banks together with rising NPLs, banks are likely to continue to avoid lending to the relatively risky private sector.

According to provisional data, the government has borrowed Rs444 billion from the banking system, during 1st July – 3rd February, FY12 to finance its current year’s fiscal deficit. This includes Rs197 billion borrowed from the SBP and show a year‐on‐year growth of 25.8 percent. Moreover, these borrowings are significantly higher than the yearly financing requirements of Rs293 billion envisaged in the FY12 budget.

The provisional estimate of fiscal deficit for H1‐FY12, from the financing side, shows a deficit of Rs532 billion or 2.5 percent of GDP. Given that the fiscal deficit is always higher in the second half of a fiscal year, by at least 0.5 percent of GDP during the last ten years, containing the FY12 fiscal deficit close to the government’s revised target of 4.7 percent of GDP would be difficult. Encouragingly, the tax collection by the Federal Board of Revenue during H1‐FY12, at Rs840 billion, has shown a strong growth of 27.1 percent. Similarly,...
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