monetaty theory and policy

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Remodelling the monetary policy (HUMAIR

Shalwani)

AN unusual thing happened last fiscal year. The private sector businesses retired in thesecond half of the year about 79 per cent of the bank loans they had taken in the first six

months, and made no additional borrowing.

On the other hand, over the same comparable period, credit flow to non-bank finance institutions(NBFC) quadrupled, creating a big imbalance between lending to PSBs (private sectorbusinesses) and NBFCs, both of which are part of the private sector.

The State Bank of Pakistan (SBP) in its monetary policy statement of August 10 came up withexplanations. But the fact that inflation remained in double digits in FY12 despite a minimalshare of private sector credit intake in overall money supply has regenerated some old debates. Is

inflation really a monetary phenomenona product of too much money chasing too few goods?Is monetary policy focussed on inflation-fighting losing importance? And, should central banksleave inflation worries behind and support government overspendings to spur economic growth?

These days even financial markets are telling us that we should be focused on jobs and growth,

wrote Paul Krugman in one of his columns in New York Times in July this year. He wasreferring to the fact that investors are now investing in US treasuries at zero and even sub-zerorates and such low-cost borrowings could be well utilised for financing public sector projectsnow to obtain a higher economic growth later on. A higher than estimated growth of 1.7 per centin US GDP in April-June proves that government borrowings from banking system actually payoff.

In last few years, Pakistan economy has expanded at a much slower rate than required to reducepoverty, feed, clothe and provide medical care to 180 million people.

Instead of trying to accelerate economic growth through liberal private sector lending, bankshave largely remained averse to it with the result that industrial output has either declined (as inFY10) or has increased slightly above one per cent (as in FY11 and FY12).

In a market-driven economy, a part of the capitalist world economic order, one can understandbanks failure in this regard. But a bigger question is: has the domestic monetary policy been of

any help in ensuring larger private sector credit off-takes to enable businesses to enhance

productivity?The SBP has the statutory authority and obligation to do whatever it can to regulate the

monetary and credit system of Pakistan and to foster its growth in the best national interest witha view to securing monetary stability and fuller utilisation of the countrys productive resources.


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The monetary policy is one key instrument to be employed to obtain this statutory goal. SeniorSBP officials claim they design the monetary policy keeping in view this somewhat very broadand unique objective in mind.

But has the SBP been regulating the banking system in a manner to achieve fuller utilisation of

the countrys productive resources?In its monetary policy statement issued on August 10, the SBP detailed the reasons for lowest-ever actual lending to private sector businessesRs18.3bn only out of the total private sectorcredit of Rs235 billion, the bulk of which Rs121bn went to non-bank finance companies.

However, the SBP authorities did not find convenient to explain this development in terms ofdemand-side issues and merely pointed outthat banks were rather more interested in investing money in government papers. The nationexpected that the central bank should have informed what it had done to correct the situation.

The cost of external financing has reduced in recent years as a percentage of overall operationalcost of businesses because of pricier energy inputs, imported inflation and handy internalfinancing available to highly profitable enterprises.

Businessmen say that compared to 1990s when bank borrowings of even the most efficientindustries accounted for at least one-fourth of the overall cost of business, such borrowings nowmerely make up 10-15 per cent of operational expenses. This means that by steering interest ratesin one direction or the other, the SBP influences a nominal change in the cost of the goods andservices produced by a companyand by extension on cost-push inflation in the country.

Keeping this in mind we are trying to remodel our monetary policy with a view to making it

more responsive to the ground realities, a senior central banker told Dawn when asked what theSBP was doing to avoid harming industrial growth in its fight against inflation.

Unlike central banks of advanced economies, our monetary policy is not built upon the

paradigm of inflation targeting. It rather aims at meeting the dual objective of ensuring sufficienteconomic growth while keeping inflation under check.

Central bankers generally agree that avoiding a deep cut in policy rate fearing faster growth inmoney creation and its impact on inflation has become a moot point even amongst them. If netcredit to private sector businesses went down to just Rs18.3 billion or about two per cent of theRs946 billion worth of money supply (M2) the argument that availability of cheaper finance to

businesses may push up prices,crumbles.

The monetary policy statement of August 10 does not mention this fact very frankly but as ithighlights other factors responsible for inflation like prices of imported goods, excessivegovernment borrowings, withdrawal of subsidies, administered prices, energy crisis etc in detail,it is easy to deduce what actually the SBP is pointing out.


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Even excessive government borrowing cannot be blamed for causing too much money chasingtoo few goods phenomenon because, afterall, government uses all the money borrowed through PIBs, TBs or even national saving schemeseither to repay domestic and foreign debts or to finance its expenses. And financing of expenses,however questionable they may be, plays a role in growthand is quite important when exports

are falling and industrial growth is stalled, says a former advisor of SBP. Governments overspending (which creates fiscal deficit) is basically what? It is income forthousands of government contractors and sub-contractors and tens of thousands of governmentemployees or for state-owned enterprises. All this, in turn, becomes part of GDP.

Commercial bankers defend their overinvestment in government papers on the same ground.They say if banks stop lending to government when demand for private sector credit is low itwould completely ruin the economy. Government officials, however, have a different point ofview.

Why banks and leasing companies cannot make money by doing more business in agriculturesector or with SMEs? Why are they contended with earnings on bills and bonds? questions an

official of the Ministry of Food Security and Research citing example of how banks and leasingcompanies can make quick bucks if they lend for agricultural development.

If this is what it is, then why fear slashing interest rates? It is not going to push up inflation. Itwill rather contain it by improving supplies of goods. But, of course, it will reduce profitabilityof those who earn not by producing anything but by actually blocking credit-flows to productivesectors.

Failure of monetary policy (Usman)By Javed A. Ansari

The State Bank has failed to control inflation, stimulate saving and investment growth, enhancefinancial sector efficiency, and reduce poverty and the inequitable distribution of financial assets.

The underlying cause of this failure is the abandonment of credit planning, which ensured bothhigh sustainable growth and price stability during 197888, and the adoption of market basedmonetary policy.

In its Annual Report 2010, a review of which has been carried out by the writer, the central banknotes that its monetary policy stance reflects its efforts to strike a balance supporting thedomestic recovery and arresting inflationary pressure. This illustrates that the SBP has not so

far formally abandoned its developmental role and it is therefore justifiable to evaluate itsperformance in terms of developmental objectivesstimulating investment growth and reducingdistributional inequities.
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Nevertheless, the SBP`s market based monetary policy paradigm presumes that growth anddistributional equity enhancement will be necessary and automatic consequence of achievingprice stability and ensuring price stability should therefore be the primary objective of the centralbank. The State Bank fully endorses this view that price stability is the main goal of (its)monetary policy.

According to the SBP`s estimates inflation declined to 11.2 per cent by the end of FY 10 from24.3 a year earlier. What part did the State Bank play in bringing about this decline? The SBPreport 2010 does not address this question.

The SBP attributes the decline to the adherence by the government to the IMF`s quarterly

ceilings in deficit monetisation along with a sharp decline in the international commodityprices.

Similarly, the rise in inflation which began in the second half of FY 2010 is attributed by theState Bank to (provision) of subsidised credit to the private sector, the planned rationalisation of

power tariffs, shortfalls in foreign inflows, rising non-performing loans, lower than expectedretirements from financing of commodity operations and increased public borrowing for publicsector enterprises; so inflation is caused by the ministry of finance, by foreign donors, by the

IMF and the international commodity markets.

When the SBP responds by increasing interest rates it does not address the causes underlyinginflation for rising interest rates do not directly influence the behaviour of government (whichwill not reduce its expenditure in response to rising interest rates) or the IMF (which will notstop insisting upon power tariff hikes) or the donors (who will not increase disbursements) orworld commodity market players (whose prices never respond to interest rate changes inPakistan).

What the State Bank is trying to do is to shift the burden to adjustment of adverse globaltendencies (rising commodity prices, donor fatigue, IMF policy preferences and increasedturmoil in currency markets) on to the Pakistani consumer, specially the poor.

The more the State Bank`s autonomy is enhanced, the more it becomes a willing servant oflending surveillance agencies and global financial markets. It seeks to compress domesticdemandi.e. exacerbate poverty and distributional inequitiesfor the purpose of enhancingglobal financial stability. An autonomous State Bank reports not to our ministry of finance but tothe IMF and the Financial Security Forum (FSF).

However, the SBP cannot play the role expected of it by the IMF and the FSF. It routinely missesits inflation targets. In FY 10, the SBP`s inflation target was nine per cent while inflation was11.7 per cent. The State Bank has missed its inflation target in 2007 (by 33 per cent), 2008 (by100 per cent), 2009 (by 90 per cent) and 2010 (by 33 per cent ). It has revised its inflation targetfor FY 11 from 11 per cent in July 2010 to 13.5 to 14.5 per cent is September 2010. MonthlyFBS estimates for the first quarter of FY 11 indicate that this target will almost certainly bemissed (by about 30 percent) and inflation is expected to range from 18 to 22 per cent in FY 11.


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The SBP`s inability to ensure price stability emanates from the fact that the preconditions for theeffectiveness of market based monetary policy simply do not exist in Pakistan.

Two decades of research at PIDE and CBM have shown that neither broad money nor reservemoney is exogenously determined, interest rate transmission mechanism are extremely weak,

demand for real money balances is not interest inelastic and the central bank necessarily plays anaccommodating role within the financial system. Most importantly, inflation in Pakistan is of acost push nature and decreasing domestic demand does not reduce the price level. It merely shiftsthe social cost of escalating prices from one segment of society (the rich) to the other (the poor).

The underdeveloped character of the financial system which makes market based monetarypolicy ineffective is recognised by the State Bank. The 2010 report notes that the financialintermediation ratio for Pakistan (M2/GDP) has declined from 45.8 in FY 07 to 39.4 per cent inFY 09 and the value of the money multiplier remained stagnant at 3.4 throughout FY 07 to 09.

In Bangladesh, the value of the M2/GDP ratio rose from 48.8 in FY 07 to 53.9 per cent in FY 09

and the value of the money multiplier rose from 4.5 to 4.7 during this period. Financially,Pakistan is more underdeveloped than Bangladesh and as the SBP recognises this financialunderdevelopment (is) a result of IMF conditionalities which impose strict limits on the

growth of NDA.

Pakistan`s financial underdevelopment is paradoxically caused by financial liberalisation. Thecurrency to deposit ratio has risen by about 11 per cent during 2007 2010 and is significantlyhigher than in any regional economy. Market based monetary policy simply cannot be effectivewhen the macro economy is definancialising. Pursuing financial liberalisation in such anenvironment is a major policy error.

M2 growth in FY 10 exceeded M2 growth in FY 09 by 26 per cent but was neverthelessgenerally in line with programme parameters agreed under the SBA with the IMF. The centralbank remained successful in meeting its NDA and NFA targets. Thus the State Bank admits its

IMF`s agency role. Ultimately it is answerable only to its principal, the IMF. It does not set anymonetary aggregate targets itself since the abandonment of credit planning. There can be noclearer evidence that the State Bank is now an imperialist currency board. It is no longer anational central bank.

This agency role is reflected in the SBP`s loss of control over NFA flows. The FY 2010 NFAimprovement the report notes was entirely due to IMF budget financing, IDA flows, the US

logistic support for participation in its war of terror, ADB inflows and the complete eliminationof SBP foreign exchange market support at the insistence of the IMF. NFA of scheduled banksdeclined significantly during FY 2010. Most significantly there was a major depletion of nostrumbalances. Under relentless IMF pressure NDA growth declined from 30.6 in FY 08 to 15.4 percent in FY 09 to just 12.7 per cent in FY 10. Private sector credit`s contribution to NFA growthhas dead-lined from 13.3 in FY 08 to just 2.4 per cent in FY 10. Government contribution toNDA growth has declined from 30.6 in FY 08 to 7.9 in FY 2009 to 7.1 per cent in FY 10. Privatesector credit`s contribution to NDA growth has declined from 13.3 in FY 08 to just 2.4 per centin FY 10.


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During FY 10, government borrowing for commodity financing and budgetary support hasbecome much more expensive again due to IMF insistence on ceilings on SBP loans to thegovernment and the consequent reliance on much more costly scheduled bank funds. As severalPost Keynesians argue reliance on commercial banks for public sector financing necessarily

exacerbates inflationary pressure. The inability of the government to meet the IMF/SBPborrowing targets during the last two quarters of FY 10 was mainly due to non-materialisationof expected flows for financing America`s war of terror.

Inflation is also likely to be exacerbated by the State Bank`s demand for phasing out energysubsidies. Although the growth of credit to public sector enterprises fell from Rs1526 billion inFY 09 to just Rs85 billion in FY 10, the State Bank continues to toe the IMF line that non-settlement of the circular debt issue in the energy sector (remains) a serious problem and arguesfor a major reductions in bank credit to public sector enterprises. The IMF credit starvation of theprivate sector continued unabated in FY 10. The SBP recognise that in real terms credit to theprivate sector declined by 13.9 per cent in FY 10.

The SBP presents no proof for its insistence that lending to the public sector crowds out

private sector lending. It admits that in FY 10, commercial banks continued to advance loans tothe private sector despite higher lending to the government. Extensive empirical research

demonstrates that in Pakistan the elasticity of substitution between public and private investmentis very low and public sector lending crowds in private investment.

The growth strangulating policy that has been imposed upon us by the IMF has led to a majorfall in private sector credit growth for fixed investment which decelerated sharply from 25.3 in

FY 09 to 8.4 per cent in FY 10. According to the State Bank Report 2010 financing for fixedinvestment by scheduled bank to the private sector amounted to just Rs45 billion in FY 10 whereas the total advances of scheduled banks in FY 10 amounted to Rs3,175 billion hence theprivate sector fixed investment loans equalled a little over one per cent of the scheduled banksadvances portfolio.

Financing fixed asset growth is of trivial importance to our financial sector. It is not surprisingthat gross fixed investment as a ratio of GDP has been falling during FY 2007 FY 2010 andhas now been reduced to a historical low of 15 per cent. During this period domestic saving as aratio of GDP has fallen from 15.7 to 9.9 per cent. Pakistan has the lowest levels of investmentand saving ratios throughout Asia.

Stimulating investment and saving growth is no concern of the State Bank. The 2010 AnnualReport lists no measures for growth stimulation either. Indeed the changes in the monetarypolicy framework it announcesthe setting up of the monetary policy committee, institution ofan interest rate corridor in the inter-bank market and the increase in the frequency of monetarypolicy decisionsare all proving to be the growth stifling.

The monetary committee is dominated by Voodoo economists; the corridor has set a floor formaintaining a high interest rate regime and every monetary decision in FY 2011 has raised thepolicy rate. The State Bank remains committed to stifling investment and productivity growth;


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and since the interest elasticity of saving is very low raising interest rates does not stimulatedomestic saving.

The State Bank proved to be ineffective in easing the very tight liquidity conditions thatprevailed in our money market during FY 10 due to the very rapid growth in non-performing

loans (NPL) The introduction of the interest rate. `Corridor` has done nothing to enhance theeffectiveness of monetary policy transmission mechanisms. All it has done is to jack up floorover might ratesfrom 1.5 in FY 09 to 7.4 per cent in FY 10. Ceiling overnight rates have risento almost 14 per cent in FY 10 but financing under the reverse report ceiling facility fell by about17 per cent in FY 10.

To prevent a fall in the floor rate the SBP allowed liquid banks to avail of a repo floor facility ofRs602.1 billion in FY 10. Thus despite an injection of over Rs3,300 billion into the primarymarket, the State Bank policy stance contributed to a tightening of money market conditionsduring FY 20.

Monetary policy and employment (Taimour)By Mahmud Ahmed |From InpaperMagzine| 8th August, 2011

The State Bank Amendment Bill 2010 has been designed to further empower the central bank tocheck excessive borrowing by the federal government in order to manage its widening fiscal

deficit. - File photo

OVER time, the SBP has acquired more autonomy to manage its monetary policy, while

keeping in view the federal governments targets for inflation and economic growth.

The State Bank Amendment Bill 2010 has been designed to further empower the central bank tocheck excessive borrowing by the federal government to manage its widening fiscal deficit.

But the SBP has failed to check excessive government borrowing from the commercial banks,giving them an opportunity to make risk- free investment with high returns. In July, however, thefederal government stopped borrowing from the central bank. Currency printing seems to havebeen ceased. And given the pause ordecline in inflationary pressures, the policy rate has alsobeen reduced by 50 basis points. At least on these two counts, the State Bank is moving in theright direction. However, much more is required to be done.

The best of institutions become dysfunctional when evolving institutional reforms fail to keeppace with fast changing ground realities or policies they pursue, outlive their social utility.

Given the current quality of economic growth which does not produce jobs, (or enough jobs)merely looking at growth figures for formulating the monetary policy is not enough.
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Employment should be tagged with growth. The objective of the monetary policy should be toachieve a high growth rate with low inflation and full employment. While inflation hurts the poorthe most, unemployment is worse for the deprived in the absence of any meaningful socialsecurity network. Inequity is the hallmark of the current banking and financial model that mustbe shed while targeting growth with social justice.

The current over-aching issue is that industries are operating at 50 per cent of their capacity andagriculture is under-performing. Monetary policy does not provide stimulus to production-ledgrowth, and thus limits the macro-economic stability that flows from a high rate of economicgrowth.

So much has changed in the world that calls for a review of the key objectives for which themonetary policy is formulated. The financial wizards have to take into account the evolvingchanges taking place in the world economies after the near collapse of the international financialsystem, resulting in the Great Recession of 2008-2009 and the prevailing toxic debt crisis in theUS and Europe. Clearly, it is the financial sector that is responsible for the unprecedented fiscal

deficits that most governments in the West are finding so difficult to manage.The debt crisis will not go away any time soon. It is now the turn of financial markets to take ahit. A strong indication is that the sagging and shrinking economies will take a very long time torecover.

If the State Bank persists with its tight monetary policy under the IMF pressure, banks willcontinue to pile up bad debts in a sluggish economy, with only government securities left tosalvage them. In all probability, stagflation would be prolonged. A high interest rate serves thebanking sector at the cost of other segments of the economy. The monetary policy needs to pushup growth.

Then the task of financial wizards is to develop a financial model that would produce highgrowth, with full employment and low inflation, something which is not possible while stickingto the failed Anglo-Saxon financial model. The so-called best international practices have turnedout to be the worst. Markets lack self-discipline.

While the State Bank should regulate lending to the government by limiting banks exposure togovernment securities, the private sector should not be penalised by the State Bank for thegovernments faults.

No doubt, the fiscal deficit and excessive government borrowing is an enormous problem. Forthis, the government is responsible and it needs to observe austerity, cut waste, eliminatecorruption and also economise on its spending. It is a task that can be better handled by electedrepresentatives, whenever they acquire a sense of responsibility. .

The issue cannot be resolved only by granting autonomy to the central bank.

Autonomy does not exist in a vacuum but is rooted in the prevailing ground realities. Have theSBP governors been able to protect their independence or their legally guaranteed tenures?


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The State Bank draws its authority and power from its mandate or charter. But it has not beenable to avoid outside influences of powerful banks, the IMF and the government. When it tries towork with a bias to favour one or the other important stakeholder, its autonomy is eroded. TheState Bank can enjoy operational freedom under a well-defined policy that serves common good.

Monetary policy discourages growth (Shaza)

From the Newspaper |Shahid Iqbal| 10th June, 2012

0

KARACHI, June 9: By keeping the interest rate unchanged, the economy can be saved

from hyper inflation, but it may suppress the already low growth rate in the country.

Experts said that the State Bank seems to have chosen an easy path by keeping the ratesunchanged while blaming the government for the economic mess.

Like State Bank, some top bankers saw no option but to keep the interest rate as high as 12 percent.

They believed that the monetary policy cannot be allowed to continue indefinitely.

There is a need to reassess the interest rate stuck at 12 per cent for past eight months, said a

senior banker.

The banks, he said, are earning good money in this high interest rate policy, but options forlending to private sector are shrinking with poor economic growth.

The State Bank has criticised banks for their reluctance to lend to the private sector which hurtsthe economic growth. The SBP says that private sector participation in economy has reducedbecause of irresponsible attitude of the commercial banks.

Banks have no option but to invest in government papers, particularly when businesses are

failing creating massive defaultsputting pressure on banks to strictly manage their risks, said a

senior banker.

Banks invest 80 per cent of their deposits in government papers.

Analysts said the fiscal deficit is a real challenge for both the government as well as the centralbank.
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The deficit forces the government to borrow huge money and compels the State Bank to manageinflation with less supply of money keeping the interest rate high.

The State Bank said it made the money policy less effective.

The central bank is facing a challenging task of monetary management amid falling rupee andmounting government borrowing, said Mohammad Sohail, Chief Executive of ToplineSecurities.

The government has borrowed Rs1.085 trillion during the 11 months of the current fiscal yearwhile rupee has lost three per cent against the US dollar during last 20 days.

Both the trends may continue to move forward until fiscal reforms to turnaround the economyare not introduced, the State Bank has said.

Mr Sohail said that along with the rupee deprecation and fiscal borrowing, the State Bank is

required to consider the overall economic growth where investment to GDP ratio has fallen torecord low level raising unemployment.

The growth rate should be the focal point of the government as well as the State Bank butgovernments massive borrowing from banking sector and the central banks fear of increasing

inflation kept the growth out of focus.

The government struggles to meet the expenses by cutting the development budget while theState Bank keeps the money supply lower, blaming the government for inflation.

Time and again the State Bank reiterated the alarming level of government borrowing as the

underpinning reason for persistent inflation despite very low GDP growth, but the governmentfailed to improve its revenue generation that forces it to borrowmore and makes the monetary policy ineffective, said Khurram Schehzad, head of research at

InvestCap Research.

He was of the view that even if Pakistan succeeds to deal with the IMF for another loan, theconditions attached with the loan would be harsher due to existing poor economic indicators.

The business community did not change their stance over the high interest rate. They said thehigher interest rate has increased their cost of doing business while it also caused greaterdefaults.

Banks said the high defaults forced them to restrict lending to the private sect

Monetary policy: a response to fiscal expansion? (Nisma)

By Sabihuddin Ghausi

State Bank Governor Dr Shamshad Akhtar did not mince words while holding fiscal
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mismanagement during the first half of current fiscal year responsible for the widening fiscal

and external account imbalances, making it imperative to further tighten the monetary policy forthe next six months.

She disclosed that the commercial banks and the central bank financed almost 60 per cent of

budget deficit from July 07 to January 29, 08 making the job of liquidity management quite`challenging`.

In the policy announced on February 1, the SBP raised the discount rate by 50 basis points to10.5 per cent that may push the lending rates of commercial banks to 13 per cent plus. The SBPalso enhanced cash reserve ratio (CRR) by 100 basis points for deposits of one-year term to eightper cent. Deposits of more than a year have been spared of CRR to give incentive to banks tooffer better rates of return to their depositors.

The risk to inflation outweighs the risk to growth, the Governor said, justifying her policy.

The Governor elaborated that the developments in first half of FY 08 substantially deviatedfrom the monetary framework, says a SBP press release on the Governor`s more than an hour-long speech on Thursday last. It warns complications for monetary management during thecourse of the year (07-08) mainly because of the slippages on fiscal deficit targets.

Industry and trade leaders came out immediately with their harsh reactions on monetary policy,warning of a further slow down of businesses and closure of enterprises. Monetary policy is amajor cause of slow growth in industrial sector and widening of economic inequalities in last fewyears, President of the Federation of Pakistan Chambers of Commerce and Industry (FPCCI)

Mr Tanvir A Sheikh said in a statement on Friday.

We are inviting State Bank of Pakistan Governor for a meeting with businessmen next week,Sheikh Amjad Rasheed, chairman of the FPCCI Banking and Credit Committee informed Dawnfrom Nowshera over telephone. He said the tight monetary policy has squeezed businessactivities beyond tolerance limits. Further monetary tightening will be killing for business`, he

warned.

Textile export factories are closing down and further tightening of monetary policy is bound to

prove the proverbial last straw on camel`s back Shabbir Ahmad, a leader of value added textileproducts exporters association said.

In their anger and fury, the industry and trade leaders overlook the government over-spending

which seems to be showing no respite. The Governor disclosed that the government borrowedover Rs237 billion so far. Last year in the same period, it borrowed only one-third of thisamount. The Governor was sceptical if the government would be in a position to retire Rs63.2billion loans as projected for 07-08 credit plan.

Where is the law that prohibits government to contain budget deficit to four per cent, asked a

trader who is confident that State Bank of Pakistan can invoke this law and put a brake onunlimited government borrowing.


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Bankers however defend the monetary policy. A top banker said that the monetary policy is themost appropriate and logical response to the current situation. It is true that inflation is on the

rise during the current fiscal year he conceded but argued, Imagine what would have been theimpact of a loose monetary policy on inflation. His assessment is that had there been no tight

monetary policy, the inflationary pressures would have been three times more than at present.

The banker repeated SBP Governor`s argument that real interest rate is still very low. Our realinterest rate is hardly 4-5 per cent if you adjust the bank`s mark-up with inflation rate is onestandard argument offered by all commercial and central bankers in support of present policies.Financial cost is just a small part of the total production cost is another argument of the bankers.

The financial cost was only three per cent of sale proceeds about five years ago, ShabbirAhmad retorted and said at present the financial cost is eight per cent of sale proceeds and ishitting the endurance limits.

The government`s reliance on banking system for borrowing has led to 19.2 per cent monetary

expansion in first half of this fiscal year. Dr Shamshad Akhtar`s advice to the government is torein in fiscal slippages in next half of thel year. She also wants the government to mutually agreewith State Bank to reduce its stock of papers from Rs624.6 billion to Rs305 billion, an averageof last five years. Her advice was for holding jumbo auctions of long-term PIBs, more issuanceof sharia-compliance instruments and to generate more inflows into National Savings Scheme.While industry and trade leaders were not in a position to offer any comment on this advice ofthe SBP Governor, a private banker confided that a plan is being prepared to shift burden oftreasury bills and short-term papers to long- term instruments.

No further details of this proposal were available but there are indications of consultations andmeetings among the bankers on these issues. The private sector has not been crowded out as

business people are trying to convey, a banker said. Private sector credit grew by 10.4 per centduring July 07 to January 19 as against 10.2 per cent growth of the same period last year. TillJanuary 5 this year, the exporters were given Rs139.6 billion as against Rs31.6 billion last year.

Under the Long-Term Financing Facility for export-oriented industries, a sum of Rs8 billion hasbeen allocated for utilisation up to June next. The borrowers have been given option to borrowfor three different terms. A three- year loan will carry eight per cent interest, five -year loan nineper cent and 10 -year loan 10 per cent.

How can we think of setting up new factories when our existing plants are being closed becauseof financial and infrastructure problems, Adil Mahmood, a leader of All Pakistan TextileAssociation (APTA) said. He wants loans on concession rates for upgrading old plants that willalso help in saving on electric and gas consumption.

Financial concessions to textile is said to have caused inflation. Akbar Sheikh, a senior APTMAleader in Lahore attributes this monetary overhang to State Bank`s wrong money supply policy.How can textile industry be held responsible for this when a slight change in money supply caneliminate this possibility, he asserted. Another textile industrialist recalled that it was high

lending that turned the industry sick in the 1990s.


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Monetary policy, govt borrowing (Danish)

By M. Ashraf Janjua

A discussion is going on, both in policy circles and in public, on the current stance of the

monetary policy.Unfortunately, this debate, divorced from the impact of fiscal operations and of governmentdirectives on monetary policy, is misplaced. Even the International Monetary Fund which hasagain been brought back in the driver`s seat due to wrong macroeconomic policies of the pastdecade, has failed to underscore the real problems of monetary policy.

Monetary policy continues to be equated with credit policy for the private sector. Credit toprivate sector is not even the main source of money creation. Historically, monetary expansionhas been largely driven by direct and indirect government borrowings, its specialised creditschemes and by the behaviour of the external sector, whose direction is also determined by the

government.There is a lack of understanding about the transmission mechanism of monetary policy as well.Monetary policy operates through control on the balance sheet of the central bank andcommercial banks. The main reliance of monetary policy in any country is on the use ofinstruments to change the balance sheet of the central bank and the commercial banks. It can bedone by a combination of instruments that impact the primary reserve base of the banking sectorand the cost of credit.

If either the cost of credit or the reserve money base of the banking system is influenced by thefiscal operations and government directives, the monetary policy degenerates into a policy aimedat rationing credit to the private sector as a residual item and to control credit cost to privatesector. The most unproductive sector will under such a scenario impose a penalty on the privatesector, which is the real engine of growth and development. Futility of such an approach either toregulate money supply or control inflation will continue to manifest in the actual outcome beingdifferent from goals of an effective monetary policy.

It is this context of the determinants of monetary expansion and transmission mechanism ofmonetary policy that led the State Bank of Pakistan (SBP) to initiate legislative reforms during1993-97 in order to insulate the balance sheets of SBP and commercial banks from theexogenous factors, including the government.

The purpose was to empower SBP to have complete control over its own balance sheet and,through it, and an independent rate of return policy, regulate the balance sheet of commercialbanks. Once SBP was empowered to control its own balance sheet and the exogenous influenceson commercial banks` balance sheet were eliminated, the board of directors of SBP couldformulate a monetary policy with the most important objective of promoting economic growthwithin the framework of relative price stability. That is the main task of any central bank andprerequisites for realisation of those objectives legislated so as to make SBP as the sole regulatorof money growth and cost of credit.
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Expansion (or contraction) of money is driven by three independent sources. It consists of publicsector borrowing from the banking system, including government initiated credit programmes forthe private sector, the injection or contraction of liquidity by the external sector depending ongovernment policies impacting foreign trade and foreign borrowings and credit demand from the

private sector.Both, public sector borrowing and changes in foreign exchange reserves have to be managed in amanner consistent with the stance of monetary policy and not the other way around. It is for thisreason that the government was mandated to limit its borrowing from SBP to the leveldetermined by its board of directors on the basis of its assessment of the absorptive capacity ofthe banking system based on a target rate of inflation and credit requirements of the privatesector.

Additional government borrowing from commercial banks were to be made through anauctioning system in which the cut off rates were to be decided by SBP based on monetary

policy requirements. Similarly, to have a say in the matter of external accounts., it was mandatedthat external account targets may be jointly worked out by the government and SBP in regularmeetings of the Fiscal and Monetary Policy Coordination Board (FMPC Board). All theseprovisions are enshrined in the amended SBP act.

But, contrary to the above legal provisions in the recent past, government has been allowed toborrow at will from SBP without any resistance from the monetary authorities. Similarly,contrary to the new provisions of SBP Act, the authority to determine cut off rate for governmentborrowing from commercial banks has been handed back to the government by SBP, and thelegal requirement of regular meeting of the FMPC Board are not being met. In fact, the legallyset up board has ceased to operate in practice.

The legal power acquired for SBP through a protracted effort of legislative reforms during 1993-97 has been in practice surrendered back to the government by SBP, and therefore monetarypolicy has taken its old form of a passive mirror image of the operations and directives of thegovernment.

The SBP is at a crossroads now having legal power to formulate and implement an independentmonetary policy and the actual state of affairs whereby it has failed to use its new legal authority.It is not the lack of legal power or lack of legislative autonomy that stands in the way offormulation and implementation of an independent monetary policy by SBP. It is the lack of willor courage to use that authority. No further legal reforms can bestow to monetary authorities thatwill and courage.

It is its own internal professional strength and moral standing that needs to be enhanced forconducting of a truly independent monetary policy that serves national economic objectives ofeconomic growth and relative price stability. It may be noted that the autonomy given to thesuperior courts in the 1973 constitution became a reality only when thewill and courage wasmustered by the sitting judges. In the same way, the legislative autonomy of SBP can only betranslated into reality by the will and courage of its governors.


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In the circumstances what is needed is professionalism and moral courage on the part of SBP toadhere to the existing provisions of the State Bank Act rather than recommending furtherchanges in laws for the formulation and implementation of an independent monetary policy. Thefault does not lie in the laws but in their enforcement. Without a check on government borrowing

from SBP as determined by its board, and without adherence by the government to the rate ofreturn policy as determined by SBP, and without regular meetings of the FMPC Board, the talkabout the autonomy of SBP or an independent monetary policy will remain futile.

(The author is professor of economics at College of Business Management and former deputygovernor (Policy) of State Bank of Pakistan)

Monetary policy and the central bank autonomy (Kainaz)

By Javed Akbar Ansari

The most serious failure of Musharraf regime was its inability to address the inherent structuralweaknesses of the national economy. The economic mandarins who were ushered into power byhim were all partisans of the Voodoo magicians (new classical economists) who believe thatwithdrawing the state from the market is both necessary and sufficient for attaining potentialoutput and steady state growth.

The present global financial turmoil illustrates the absurdity of this doctrine so dramatically thatfurther comment becomes unnecessary.

Musharraf`s economic team has comprehensively dismembered monetary policy and laid thebasis of a full fledged financial crisis. Their monetary policy has imposed a terrible cost on the

poor.This article will detail the cost borne by the poor of faulty monetary policy and outline someexpectations of the poor from the new supposedly social democratic regime. (Remember roti,kapra aur makan).

The most painful cost borne by the poor of monetary policy is of course inflation. CPI growthrose from 7.8 per cent in FY07 to 12.0 per cent in FY08- a rise of over 50 per cent.

The inflation accelerated in the second half of FY08 after the SBP had raised the discount ratethrice, cash reserve requirements twice and statutory reserve requirements to almost 20 per cent.

A major cause of accelerated food inflation was the ineffectiveness of monetary policy measuresin stimulating agricultural production, growth of which was halvedfalling from 3.7 per cent inFY07 to 1.5 per cent in FY08. The SBP attributes this as it attributes almost all of its failures topolicy errors of the government.

The State Bank puts the blame for all of the illshigh inflation external and fiscal imbalancesand crowding out of private investment on government`s SBP borrowing.
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However, the SBP Report FY 2008 presents no evidence estimating the actual contribution of thegovernment`s SBP borrowing to the growth of inflation and external and fiscal imbalances.Attributing inflation to central bank borrowing by the government is an obsolete Voodoodoctrine discredited by post-Keynesian economists such as Goodley and Lavoie whodemonstrate conclusively that this need not be the case especially when the economy faces cost

push inflation as is the case in Pakistan.In the SBP Annual Report 2008 blaming the post-Musharraf government for all policy failures ofthe State Bank is a constant theme. The State Bank under Shamshad Akhtar wants the PPPgovernment to adopt a faulty policy stance cutting back all subsidies, abandoning the poor andmortgaging monetary sovereignty to the IMF.

Subservience to Voodoo monetarist doctrine has eroded the State Bank`s control over moneysupply; in FY08 reserve money grew by 21 per cent -faster than in FY07. The SBP`s policytransmission mechanismthe impact of changes in the discount rate on bank retail ratesweakened significantly, the rupee depreciated dramatically and the current account deficit rose to

8.4 per cent of GDP. All this says the State Bank report was exclusively due to the sins of thegovernment especially its refusal to cut food and oil subsidies. The SBP is thus not responsiblefor anything.

The SBP can find no ground for blaming the government for the ineffectiveness of its interestrate policy in controlling private sector credit demand, so for this it blames NBFCs epeciallymutual funds.

The SBP`s comprehensive failure in controlling inflation is reflected in the trimmed mean coreinflation measure (a measure of inflation supposed to measure only those price changes

influenced by monetary policy). This registered a year- on- year rise of 17.2 per cent by June 08

as against 8.7 per cent the previous year. The SBP presents no evidence to substantiate its claimthat the FY08 inflationary pressures. stems from global price shock.

Empirical studies at CBM and PIDE show that this is not the case. Nor is there any evidence toshow that the SBP has any capability to reduce the first round or second round pass througheffects of rising global prices.

Quite the contrary, the SBP lauds the government`s bold decision to pass on to the consumers

the cost of imported inputs. This will ensure allocativeefficiency.

SBP recognition of the ineffectiveness of its tight monetary policy became evident in the firstquarter of FY09 when it responded to the Pakistan market`s credit crunch by a drastic reductionin reserves, a massive liquidity injection through OMO`s and discount rate cuts, reduction ofcash reserves requirements and abolition of SLR for a significant proportion of bank depositors.

SBP`s claim that monetary over hang was significantly reduced during FY08 is false. M2 grewby over 15 per cent in FY08. M2 has grown significantly faster than nominal GDP during mostof FY00 to FY08 and Ishrat Hussain`s cheap money policy has been a major cause of acceleratedinflationary pressure.


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In FY08, the difference between M2 growth (16 per cent) and GDP growth (19 per cent) wassmall. The fall in M2 growth is entirely due to

the negative growth of net foreign assets (minus 32 per cent) over which of course the SBP hasno control. Had NFA growth been non-negative (zero) M2 growth would have significantly

exceeded nominal GDP growth in FY08. During FY08 domestic credit net grew by 30 per centand other assets net by 20 per cent. Actual M2 growth exceeded targeted M2 growth by 14 percent. There is virtually no difference in the M2 growth rate of FY07 and FY08 if we exclude theexceptional M2 growth rate of June 2007.It is Ishrat Hussain`s policy of stimulating consumercredit demand which is hurting the poor. The incidence of inflation is highest on the lowestincome group according to the State Bank which defines the lowest income group as those withincome levels below Rs.3,000 per month. While the poor are starving, consumer demandremains strong. We continue to import Cadillacs from America and perfume from Paris. It is thisartificially bloated consumer demand which has led to the explosive growth of the currentaccount deficit and the massive draw down of foreign reserves in FY08.

The policy makers loss of control over the macro economy is illustrated by the dramatic changein the overall external balance. The FY07 surplus of $ 3.7 billion was converted into a hugedeficit of $5.8 billion in FY08. Inflow of foreign capital also decelerated significantly duringFY08. Monetary policy has been as ineffective in stabilising foreign capital flows as it has beenin restraining consumer credit demand.

The ineffectiveness of monetary policy is also reflected in the deceleration of bank depositgrowth. Deposit growth declined by more than 25 per cent in FY08 compared to FY07 despitethe rise in interest rates. Interest rate changes also did not succeed in reducing bank lending tothe private sector. Bank advances growth was concentrated in the corporate sector and was forworking capital and trade financing. Advances for fixed investment declined during FY08 and

the agriculture and the small scale sector remained acutely credit starved.Decline in deposit growth was accompanied by a drop in the over all M2 to GDP ratio. This wasalso the result of decline in NFA and indicates the increased external sector vulnerability of thetottering monetary management system. The sharp increase in the currency to deposit ratio inFY08 indicates the lack of confidence of the public in the banking system. This is also reflectedin the rapid growth of foreign currency deposits during FY08. Rising risk is also indicated by thesharp rise in the credit / deposit ratio which at end of FY08 exceeded 82 per cent.

The SBP jacked up the interest rate structure during FY08 but average deposit to average lendingrate spread remains at about seven per cent. Foreign bank lending to deposit rate spread hasincreased and most foreign banks continue to ignore the five per cent saving deposit rate floor setby SBP, on one pretext or another.

SBP`s liquidity management was also a failure -as usual, the SBP blames the government forthis. Overnight repo rates remained highly volatile. The SBP failed to retain commercial bankinterest in TB auctions which is the main reason behind expanded government borrowing fromSBP. Increase in TB cut of rates was quite ineffective. Debt maturities roll over proved to bevery inadequate. Investments in PIBs fell by more than 20 per cent during FY08.


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Market based monetary policy has, during FY00-FY08, manifestly failed to achieve itsobjectivesensure monetary stability, control inflation, effectively regulate reserve money andcredit money growth. But its greatest crime is that of omission. The SBP prides itself on havingno distributional targets. What this means in practice is that the SBP encourages the scheduledbanks to play an exploitative role.

This becomes evident when we look at the distribution of bank deposit and credit accounts.Banks are serving as a vehicle for transferring billions of rupees from the poor to the rich everyyear. This is where their profits come from.

In 2008, those with deposits of less than Rs0.1 million each (the poor) held 78 per cent of thetotal number of bank deposit accounts. However, their share of the total amount in theseaccounts was only 15 per cent. As against this, those with more than Rs5 million in theiraccounts had less than 0.1 per cent of the total number of bank deposit accounts but their share oftotal bank deposits was 37 per cent.

In 2008, the poor (those with less than Rs0.1 million each) had 68 per cent of total bankadvances accounts but their share in bank advances was less then 0.6 per cent.

As against this, the share of those with more than Rs5 million in their advances accounts wasonly five per cent of the total number of advance accounts but their share of total amount lent bythe banks was over 70 per cent.

Banks transfer funds from the poor to the rich. Total deposit of the poor (those with less thanRs0.1 million) amounted to Rs584.7 billion in 2008. The total amount lent to them by the bankswas only Rs28.8 billion.

The total amount lent to the rich (those with investment account limits in excess of Rs5 million)was Rs1973.8 billion. The deposits of the rich in 2008 were Rs1394.5 billion-thus the bankstransferred Rs594.3 billion to the rich. This transfer of money from the poor to the rich hashappened every year during 1999 to 2008. During this period, according to one CBM estimate, atleast Rs3 trillion have been transferred from the poor to the rich by the banking system.

The vast majority of the population have no accents to the banking system. The number ofdeposit accounts have been falling every year during FY2000 to FY2008. In FY2008, there wereonly 24.9 million deposit accounts. Depositors, of course, have several accounts each. Accordingto NBP research, the total deposit accounts to total depositors ratio is 1.4. This means that onlyabout 18 million people in a population of 163 million have bank deposit accounts, 89 per centnever need to open the door of a bank.

This grotesque mal-distributive financial system preys upon the poor. Its distortions areaccentuated by market based monetary policy which presumes the universal validity of Voodoomacroeconomic theory.

Voodoo (representative agent) macroeconomics presumes that


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Money supply (especially reserve money) is an exogenous variable.

Saving, investment, bank lending etc. are sufficiently interest elastic to make the centralbank chosen interest rate structure a fulcrum in the monetary policy transmission mechanism.

An optimum output maximising real sector equilibrium is automatically generated when thecentral bank chooses the right interest rate structure and this also automatically generates a

welfare maximising pattern of income distribution. Government borrowing from the centralbank is necessarily inflation enhancing and therefore fiscal policy should be subordinated tomonetary policy.

Post Keynesians and Neo Saraffn`s have detailed the grotesque deliberate misrepresentation ofcapitalist order functioning that is implicit in these assumptions. Extensive research at PIDE,CBM and AERC has shown that the Pakistan economy certainly does not work in this way.Neither investment nor saving nor bank credit is interest elastic. Both M2 and Mo areendogenous variables; manipulating interest rates is not an effective way of influencing

macroeconomic aggregates.Equilibrium generated by accommodation to market investment and consumption preferences

does not yield stable or sustainable or equitable growth. There is no proof that central bankborrowing by the government is inflation enhancing.

Increasing low cost public borrowing is an indispensable necessity for increasing the real incomeof the poor, significantly expanding public investment and loosening the stranglehold ofmultinational agencies on policy making. If the PPP is seriously committed to a socialdemocratic policy agenda, it must

abandon market based monetary policy due to its comprehensive systemic failure andrecognise the reactionary character of the Voodoo macroeconomic theoretical paradigms whichunderlies it.

reinstitute credit planning. This requires a leadership with hands on experience of credit

planning.

monetary policy objectives should be distributional not macros aggregative. A growing realor financial market does not take care of the poor. That is why the state must govern the marketby becoming a major consumer and investor.

abolish the autonomy of the SBP (this has transformed it into pro-West Currency Board),nationalise all banks and NBFCs and impose strict capital controls on both current and capitalaccount transactions.

The PPP will, of course, do none of this. The PPP has already finalised a medium-termagreement with the IMF which gives the IMF policy oversight rights. But failure to addressdistributional inequities will discredit the PPP.


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A non-traditional monetary policy (Omear)

From InpaperMagzine| 16th April, 2012

0

KEEPING its key policy rate unchanged at 12 per cent and increasing the lowest

mandatory return on saving deposits from five to six per cent, the State Bank of Pakistan

has sent important signals to all market forces, senior bankers say.

Whereas the maintenance of discount rate at 12 per cent aims at containing inflation, the raisingof the rate-floor for saving deposits means the SBP is aware of the complex fiscal and monetaryissues and wants banks to be part of the solution.

Banks were expecting the policy rate to remain intact. But they had no idea that the central bankwould scale up the floor for the PLS rates of return, remarked head of a large local bank.

Economic justifications do exist for the twin moves, and the SBP has elaborated on them. Butas bankers, our problem is that if we have to raise the mandatory minimum deposit rates on PLSsavings we cannot immediately do it without increasing the lending rates, he said.

Now, has the SBP signalled banks to move towards higher interest rates without revisingupwards its own discount rate? And does it want banks to increase the saving deposit rates inexchange for it?

A careful reading of the monetary policy statement provides some clues: After recently-imposedrestriction on the government to keep its borrowings from the SBP at zero level by the end of thequarter, the central bank may have to ensure sufficient liquidity into the banking system to let thegovernment borrow from banks. At the same time it also needs to ensure that theprivate sector credit demand is not crowded out.

This means that banks would tend to make private sector loans dearer. Since interest rates arealready high this may eclipse the economic growth prospects. One way to deal with thisproblem is to ensure that banks generate liquidity on their own. That ishow they can become part of the solution (of impending problems) and that is why the centralbank wants them to increase return on the PLS saving deposits, explained a former executive

director of the central bank.Currently average return on saving deposits is 5.25 per cent. Increasing it to six per cent without

necessarily revising up lending rates is no big deal if banks cut some of their operationalexpenses, he suggested. Saving deposits make up 38 per cent of the total bank deposits and

enhancing the lowest acceptable return on them to six per cent would bring in a lot of money intothe banking system, he argued quoting statistics from the SBP monetary policy statement.
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Bankers say, however, that increasing the minimum return on saving deposits at a time when thegovernment has re-allowed institutional investment into the National Saving Schemes would beproblematic for them. If banks can expand their deposit base by a certain margin by increasingthe rates of return on the PLS saving deposits its impact would be offset by the outflow ofinstitutional funds from banks into the NSS, feared treasurer of a local bank.

The Economic Coordination Committee of the federal cabinet had decided on April 6 thatspecial funds like pension, gratuity, superannuation, provident fund and trust funds would be

eligible to invest in the NSS. Last year, they too had been declared illegible for investing in theNSS along with other institutional funds.

From the government point of view, this move would be helpful in increasing its borrowing fromnon-bank sources thereby containing its bank borrowing and creating more space for banks tolend to the private sector. The reason why banks are disturbed over it is not because it wouldcause an outflow from their deposit base, commented a senior official of the Central Directorate

of National Savings.

They are disturbed because they know that the wider our scope for non-bank borrowingbecomes the lesser we would rely on banking loans. And opportunity for them to continue toinvest in zero-risk government papers would become limited, he said adding that the SBP hadfrequently warned banks against overexposure in government securities.

That banks over-investment in government securities has reached the levels where the centralbank had to warn them against what it calls financial disintermediation is evident from the fact

that ADR (advances to deposit ratio) of the banking systemplunged to 53.6 per cent in 2011 from 69.7 per cent in 2007a steep decline of 16 percentagepoints within just four years.

The government is partly to be blamed (for this situation) as it continued borrowing too heavily

from banks during these years.

But as a regulator, the central bank is ought to make moves to dissuade banks from letting theADR deteriorate further, commented a senior central banker.

He recalled how in the past the central bank had introduced the concept of interest rates corridor(thereby discouraging banks to sit on liquidity only in search for occasions to employ it ingovernment papers and compelling them rather to use the same for loaning to the private sector).

Now the twin moves of keeping its own policy rate unchanged (and that too with the interestrates corridor concept) alive and requiring banks to raise the return on saving deposits from fiveto six per cent, the SBP has again signalled to banks that they should not forget their role asfinancial intermediaries.

I think the present monetary policy is non-traditional in that it seeks to obtain this objective aswell apart from ensuring interest rates stability, he said.Mohiuddin Aazim


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Monetary policy and financial sector efficiency (Ramsha)

By Javed A. Ansari

Financial liberalisation and market-based monetary policy are said to be necessary for improvingfinancial sector efficiency. This has not been Pakistan`s experience since 1988.

The most striking feature during this period is the distancing between the real commodityproducing sectors on the one hand and the financial sector on the other. Thus in calendar 2009according to the SBP report, the performance of the banking sector largely reflects the shift in

the banks risk preferences, strong government demand for bank finance and amendments inprudential regulations.

Banks shifted out of real sector investments to investments in risk free government securities.However the maturity mismatch between assets and liabilities increased sharply during FY 10.Banks invested heavily in longer term treasury bills but attracted short term or low interestyielding deposits.

Profits grew massivelyby over Rs54 billion in FY 10 despite a weak real sector growthperformance and rising non-performing loans (NPLs). As the report notes, profitability waslargely the result of amendments in the prudential regulations by the SBP (which led to) a sharpslow down in expenses growth due to lower provision related expenses.

Amendments in the SBP`s prudential regulations allowed banks to use a part of the forced salesvalue (FSV) of pledged collateral in provisioning for impaired assets. Provisioning as aproportion of banks income declined precisely at a time when the NPLs were skyrocketing. Ifthis is not institutionalised corruption, what is?
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Financial liberalisation has not led to a noticeable increase in banking industry competitiveness.The largest banks had the highest profitability and interest margins ratios during 2008 and 2009(figures for 2010 are not yet available). The largest banks have the highest spread betweendeposit and advances rates and the lowest cost deposit base.

The interest rate spread between advance and deposit rates has averaged about 9.5 per centduring FY 01 to FY 10. In FY 10 the average interest paid to depositors was 4.2 per cent whilethe weighted average lending rate (WALR) was 13.6, the spread was thus 9.4 per cent. Thepattern of inter- regional credit distribution is highly unjust. Thus during 2005 09 Balochistan`sshare of bank credit was 0.6; KP`s 2.3 and Azad Kashmir`s 0.3 per cent. On the other Sindh`s i.e.Karachi`s share of bank credit was about 42 per cent.

Bank inefficiency is reflected above all in the rising volume of loan write-offs and NPLs. TheSBP report provides no figures on officially sanctioned loan write-offs although according to aSupreme Court decision these should be provided on a time series basis. Non performing loansof our banking system rose by 15.6 per cent during FY 10 and reached Rs460 billion by end of

FY 10the stock of non performing loans rose by Rs62 billion in FY 10. The SBP expects noneof these additional NPLs to be recovered for while the stock of these loans has gone up by Rs62billion in FY 10,. loss category (non- recoverable) loans are estimated to have increased byRs93 billion

Two-thirds of these NPLs are those of the corporate sector. Despite this there are no plans for thefinancial restructuring and rehabilitation of sick projects by the SBP or any other governmentagency. It is therefore not unfair to conclude that money market based monetary policy has failedin improving the efficiency of the financial sector.

But the greatest victims of market based monetary policy are the poor. Market based monetarypolicy fuels inflation throughout the economy by jacking up financial costs and refusing torecognise that inflation in Pakistan is a cost push phenomenon. It has always been so for as theLatin American Structionalists have shown, in a country where the majority of the population isliterally starving to death demand pull inflation is strictly an illusion of Voodoo economists.

In Pakistan, the lowest income group has always been the hardest hit by inflation. Food inflationhas been higher than non-food inflation through most of FY 06 to FY 10. Moreover during thisperiod prices (as reflected in the sensitive price index) have risen fastest for the lowest incomegroup (those with monthly incomes of Rs3000 and less according to the SBP. The inability of theSBP to deal with the real causes of inflationthe cost factorshurts the poor more than it hurtsany one else.

But of much greater significance is the fact that the State Bank`s liberalised financial systemdiscriminates against the poor. This becomes clear when we look at the structure of deposit andadvance accounts in scheduled banks. In June 2010 the poorthose with accounts of less thanRs1 lakhowned about 40 per cent of the number of deposit accounts. Their share in totalamount deposited was about 15 per cent.

The richthose with deposit accounts of Rs10 million and moreowned only 0.1 per cent of


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the total number of deposit accounts but their share of the amount deposited was about 37 percent.

As against this, the share of the poor in the amount that banks lent was only 0.9 and the share ofthe rich was as high as 80 per cent. The total amount deposited by the poor at scheduled banks at

end FY 10 was Rs714.4 billion but the total amount lent to them was only Rs27.4 billionhenceRs687 billion were taken away from the poor As against this, the total amount deposited by therich was Rs1751.3 billion while Rs2446.6 billion was lent to them by the banks. This means thatRs695.3 billion were transferred to the rich.

The banking system is an institutionalised mechanism for transfer of funds from the poor to therich. CBM estimates that over the period 200510 approximately Rs3.5 trillion have beentransferred from the poor to rich through the banking system. The poor are starving to death andthe rich enjoy a standard of living which is the envy of the European and the American elite. TheState Bank is among the main managers of this viciously cruel economic system whichrelentlessly exacerbates the exploitation of the poor.

Market based monetary policy has failed comprehensively. The State Bank`s monetary stanceexacerbates inflation, stifles investment growth, fosters financial sector inefficiency andviciously discriminates against the poor. Policy reform within this macroeconomic framework isa sick joke. This policy framework must be totally abandoned.

We must break decisively with the IMF and reject all foreign set macroeconomic targets;reinstitute credit planning and impose rigorous credit and capital controls, nationalise allfinancial institutions and abolish the money market and repudiate all foreign debt.

The writer is Dean CBM

Political monetary policy (Lalani)

By Dr Pervez Tahir

FISCAL policy is by definition political; it is made by politicians. In contrast, monetary policy iskept away from political rulers in all functioning democracies.

Generally a non-political professional is appointed, not elected, as the head of the central bankand left alone to take an independent view of the economic and financial data to announce amonetary policy in the best interest of the economy. It is hard to apply this description to themonetary policy just announced by the State Bank of Pakistan.

The monetary stance seems to have been decided in the cabinet meeting held in early Januaryand announced as such by the information minister at a press briefing that usually follows. Theindustries minister has been telling all and sundry in business that the government will not allowan increase in the interest rate. The adviser on finance too did not leave any doubt that the State
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Bank had to be a team player. What was left for the State Bank was to make a detailedjustificatory statement, which has been done in the form of the latest monetary statement.

Both the government and the State Bank face a public relations dilemma. They are unable toexplain in common parlance why the interest rate in Pakistan is following a different trajectory

from that in every other country of the world. Rising inflation was easy to blame on the globalhike in food and energy prices, but persistent core inflation is not. While the State Bank governorwas at a loss to interpret the usual divergence between the wholesale price index and theconsumer price index, the real issue for him was the core inflation. The fact is that core inflationis not moving at all. It was 18.9 per cent in November and 18.8 per cent in December. Variationof a few points at these high levels is of no significance at all.

If the State Bank had followed the principles of monetary economics, and its own researchedposition that financial charges are

not a major component of the cost of doing business, then the discount rate should have been

increased, not necessarily to the full extent of 150 basis points to please the IMF but by 50 basispoints to make an unambiguous statement of intent. By following the government lead to keepthe rate unchanged, the market expectation cannot but be of a cut the next time. By changing thefrequency of monetary policy statements from half-yearly to quarterly, such expectations wouldbe reinforced. The situation will not be helped by the fact that Pakistan does not have quarterlyGDP data, making an assessment of nominal GDP that much difficult.

There is, however, more to the shift to quarterly announcements than meets the eye. In case theassessment in the forthcoming IMF review goes the other way, ignoring the democracy dividendplea put forth to the IMF first deputy managing director John Lipsky in Davos by the primeminister, the State Bank will have to suffer the ignominy of having to announce an interim

monetary policy.A quarterly statement will come in handy here. Let it be understood though that unfulfilledbusiness expectations of a cut in a quarter from now will have a more devastating effect thantheir present disappointment over no change in the rate. And let it be also understood that theIMF is likely to be guided more by the commitment to achieve a June-on-June inflation rate of12 per cent than anything else. The time was thus not yet to relax.

In a word, the do-nothing policy aimed to please the government, appease business and confusethe public is likely to add to the prevailing uncertainty. Projecting a GDP growth of 3.7 per centin the current year against the earlier IMF projection of 3.5 per cent and the latest World Bankprojection of three per cent makes the confusion worse confounded.

I have written earlier in these columns that we would be lucky if the GDP growth rate this yearstays slightly above the population growth, unless the witch doctors of the Shaukat Aziz era, whocontinue to be in the employ of the government, are called upon to regroup their dirty-trickssquad to spike the growth rate. This will be the last nail in the coffin of the integrity of ourstatistical system.


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The writer holds the Mahbub ul Haq Chair in Economics at the GC University, Lahore.

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monetaty theory and policy