Text of SBP chief's speech on Monetary Policy Statement

KARACHI (APP) - Following is the text of the speech of Governor SBP Syed Salim Raza delivered at a press conference on MPS held at SBP Karachi Monday.
In a deregulated and substantially open economy, such as Pakistan, sustainable growth will need the confidence of domestic and foreign constituents in the willingness and capacity of economic management. To maintain that balance in monetary and fiscal policy, as is necessary to provide economic agents a viable base for long term decision making, and for economic management to act quickly and firmly to restore stability when imbalances emerge.
In context, Pakistans economy has made steady progress on its path towards macroeconomic stability. Though still higher than desired, CPI inflation (YoY) declined to 19.1pc in March, 2009 from a high of 25.3 percent in August, 2008. Persistent demand pressures, as depicted in core inflation measures, have also eased. The 20-percent trimmed core inflation has come down by about 2.4 percentage points from its peak in October, 2008. Although the projected average CPI inflation for FY09 is around 21 percent, expected inflation of around 14 percent for Q4-FY09 and 8 percent for FY10 illustrates a positive outlook.
Improved fiscal discipline, and contraction in the external current account deficit, indicates that aggregate demand is trending down. This will help narrow the output gap and strengthen the positive outlook for inflation.
Fiscal deficit of Rs 251b (1.9 percent of projected GDP) for H1-FY09 and the governments commitment to cap it at Rs 562b (4.3 percent of projected GDP) for the entire FY09 is a very significant improvement over last years 7.4 percent.
Similarly, the external current account deficit has narrowed to $172m in March, 2009 compared to a deficit of $2.2b in October, 2008, showing much improved trends in the external sector.
Cumulatively, the external current account deficit for the first nine months of FY09 stands at $7.6b and is projected to be $9b or 5.5pc of the full year GDP.
Tight monetary policy, together with the rationalization of fiscal subsidies and expenditure controls, are the key policy actions that have delivered improvement in these deficits. The efforts of the SBP and the government to achieve macroeconomic stability were also supported by market induced adjustments in the exchange rate, and by fall in the international oil prices.
Consistent with the macroeco-nomic stabilization program, which is supported by a Stand-By Arrangement (SBA) with the IMF, the stock of government borrowings from the SBP has remained well within the target of Rs 1.274 trillion applying to end-December, 2008 and end-March, 2009. Given the level of this stock at Rs 1.094 trillion as on 16 April, 2009, the likelihood is that the end-June target of Rs 1181b will be met.
Similarly, increase in SBPs foreign exchange reserve of $4.3b between November - April, FY09 and projections that this level will increase to $9.1b by end-June, 2009 is also a key indicator of emerging macroeconomic stability.
The containment of these twin deficits has reduced demand pressures and helped to align, to some extent, the investment capacity of the economy with the limited availability of foreign and domestic savings. The impact of these adjustments is visible in monetary aggregates. The necessary measure of restricting government borrowing from the SBP has restricted reserve money creation in the system as has the low, albeit gradually improving, foreign exchange reserve position. Consequently, overall liquidity (M2) in the economy remains tight. The equilibrium growth rate of M2, consistent with projections for fiscal and external current account deficits, is expected to be around 8 percent or half of that in the comparable period last year.
A significant source of M2 slackness has been the fall off in private sector credit demand, for both demand and supply reasons, as we will see later. Total private credit growth for the last 9 months has been only Rs 48b, versus Rs 345b for this period last year. As a result banks have built up considerable excess liquidity, some Rs 410b or about 10% above their reserve requirements. This has allowed comfortable accommodation of Government rollover of maturing bills, Rs 1.475 trillion being bid against Rs 700b accepted bills. At the same time, the share of 12 month bills in the volumes bid has steadily increased after a long period when 12 month bills o/s remained entirely static. The market has also comfortably accommodated Rs 142b growth in PSE needs, about Rs 105b more than last year.
The last month has seen a little tightness in rates, with 6 month KIBOR and 6 month T bills both moving up about 66 bps and 108 bps respectively. Much of this tightness emanated from the auction coinciding with the substantial Tax payments to Government at quarter end March, and is expected to be temporary. The positive view of the lower long term rate expectations was reinforced by the PIB bidding on April 15, where about Rs 50b was bid for a target volume of Rs 20b, where the heaviest volume bid was for the 10 year bond, at 1.7% below the rate for the last auction.
It is noted here that MOF now determines T-Bill rates and that it has shown consistent discipline in picking volumes very close to the volumes offered, with a bias to building up longer term liabilities. This trend allows debt rollovers to spread over all 4 quarter, instead of over half the total volumes being bunched into a single quarter, as had historically become the case.
Rising NFA and high agricultural procurement prices will tend to build up the supply of bank deposits and M2 in the short term. Progressively, improving private sector demand will also spur the bank multiplier.
Now, the positive outlook for inflation provides ground for economic recovery. Though, the real challenge here is to improve the business climate. The difficulty is that not only has the demand for credit by the private sector reduced sharply but that the supply of credit by banks has also remained subdued, and the two issues are difficult to disentangle.
Slowdown in domestic economic activity exacerbated by power shortages, decline in domestic demand, as well as in external demand due to the global recession, and tight monetary policy all influenced the fall in demand for credit by the private sector. Negative wealth effect transmitted through a fall in assets (stock markets and property) prices has also played their part in this decline of demand. On the other hand, rising Non Performing Loans (NPLs) and the availability of alternate avenues to extend credit, such as to government and Public Sector Enterprises (PSEs), has allowed the banks to follow a strategy of risk aversion and avoid building private sector exposure in an uncertain environment. Easing the monetary policy stance to some extent will send a positive signal in this context but may not be sufficient to fully revive the PSC and thus growth prospects, by itself.
There are other immediate concerns that call for caution. With falling economic activity there is a risk of slippage in the tax revenues.
Against a target of Rs 1.300 trillion for FY09, Federal Bureau of Revenue (FBR) has collected Rs 810b during the first nine months. This means that Rs 490b or Rs 163b per month needs to be collected in the remaining three months, which may be difficult. The expected shortfall, if any, will likely be compensated by non-tax revenues - in particular, through the differential between international and domestic oil prices.
However, the government is entirely cognizant of the urgency of enhanced tax revenues and is planning administrative measures, such as tax audits, and evaluating alternatives to broaden the tax base across all sectors of the economy. Success will be critical, going forward.
Also, the outlook for the external sector remains somewhat vulnerable. The deepening global recession would affect Pakistans exports. Against an actual export growth of 0.2 percent in the first nine months of FY09, the projected fall in exports of 6.5 percent for the entire FY09 is a reflection fast changing global conditions. However, the projected decline in imports 14 percent provides some respite for the fall in trade account. Up till March, 2009, workers remittances at $5.7b appear very strong and FDI at $3b look fairly stable - but the outlook is uncertain. Also, portfolio investment inflows have reversed by $1b. Given weak prospects for tapping international financial markets, the reliance on multilateral and on bilateral loans, to improve the overall balance of payment position, has increased.
So, despite substantial improvement in the outlook of many important economic indicators, sustainable medium term recovery remains a challenge. There are structural issues with respect to business conditions that need to be tackled. Most importantly, severe domestic power shortages and unpredictable security conditions complicate the outlook for rapid growth in productive activity in the economy.
Fully recognizing these factors as constraints, at least in the short run, the focus of the SBP remains to fully capitalize on the emerging signs of macroeconomic stability. The assessment that inflation will continue to fall persuades us that the SBP can now afford some relaxation in its monetary policy stance in favor of stimulating real economic activity. Therefore, SBP has will lower the policy discount rate by 100 bps to 14 percent effective 21 April, 2009.
As monetary partners in achieving the overall objectives of the economy and making strategy, we remain committed to playing our complementary role in aiming to provide both the price stability and the essential liquidity that Pakistans economy requires for sustainable growth.