THE State Bank of Pakistan is due to announce its new monetary policy on August 10. Financial markets are abuzz with discussions on the magnitude of a cut in central bank key policy rate—rather than the question on whether the central bank will go for it.
The recent decline in secondary market yields on Pakistan Investment Bonds and some softening in returns on treasury bills show markets are quite positive about possible rate reduction.
The fall of CPI inflation to a 31-month low and below 10 per cent in July—after seven long months—has raised hopes for reduction in the SBP discount rate, remaining unchanged at 12 per cent since October 10, 2011.
Business leaders often blame low growth in industrial output partly to energy crisis and partly to high interest rates. As the central bank is now set to review its monetary policy for August and September, business lobbies and chambers of commerce and industry have stepped up their demand for the rate cut. “Should the policy rate be cut? I think yes, But by what margin? I can’t say,” said a central banker whose input is important in monetary policy reviews. He refused to make further comments and hastened to add: “It’s purely my personal view.”
Sources close to SBP say most central bankers are of the view that holding on to the current level of policy rate would continue to hurt economic growth and impact negatively on investment. But whether the central bank would go for a slight cut or choose to slash the rate “falls in the domain of the board of directors”. Industry has been demanding 150-200bps slashing of the rate. But if the guesstimates of top bankers and the SBP sources serve as any indication “then the rate-cut would be somewhere between 50-100 basis points,” according to head of a private bank.
Analysts at brokerage houses like BMA Capital and Topline have also expressed hopes for a minimum rate cut of 50bps and have cited the recent release of $1.118 billion of stuck up Coalition Support Fund by the US as something that should lessen SBP’s worries over fiscal constraints.
Because of fiscal constraints the federal government had made excessive borrowings from the central bank in FY12 making it difficult for the SBP to consider a rate cut.
“Now there are indications that the government’s central bank borrowing would not be as huge as in the last fiscal year. You’ve got CSF ($1.118bn), you’re going to get more from the US under Kerry Lugar Act and there is a possibility of a part of $700 million from Etisalat on account of PTCL privatisation. All this is going to happen during the current fiscal year,” pointed out a senior executive of state-run National Bank of Pakistan.
“I believe it’s time for a rate cut,” said a former central banker. “I don’t know what would be the outcome of deliberations of the (monetary policy) committee. But our economy needs a shot in the arm right now. Exports declined in the last fiscal year and the LSM (large-scale manufacturing) grew one and a quarter percentage point only. If we want our industries to grow faster, which is also essential for boosting exports, I think businesses need a low interest rate environment. They are already troubled by power outages which are not going to go away very soon.”
More than half a dozen treasurers of local and foreign banks contacted by Dawn said they feel the central bank would go for a rate cut this time. “The argument that government’s inflationary borrowings from the central bank may remain high in this election year is less relevant,” one of them said.
“After all, whatever economic growth the country has posted in last few years has come about in the same environment—high government borrowings both from the central bank and commercial banks.” When the private sector activity slows down, squeezing government spending does not work either.
“The champions of austerity theory in America and Eurozone are now revisiting their thoughts after they realised that when economic growth is sluggish the government spending should not be slashed,” said a former advisor to the SBP.
He and some others who favour rate cut, say core inflation still remains in double digits because monetary expansion has taken place in last few years without big enlargement of private sector credit (except for in FY12) and growth in currency in circulation has also remained strong.
“Unless you tap currency in circulation effectively, overall money supply M2 would keep expanding, producing inflation. And unless you let private sector borrowings from banks rise dramatically during an economic slowdown, the supply side improvement in the economy would not be much in sight. As a result, the core inflation would not easily decline,” said another former central banker setting aside fears that high core inflation may compel the central bank to keep interest rates unchanged.
“Besides, if non-food non-fuel core inflation stays high it is a proof that agricultural and industrial activity is slowing down with not enough goods being produced to cater to the local demand and still leave export surplus. In that case, a rate cut becomes all the more important.”