Text of SBP chief's speech on Monetary Policy Statement

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 Pakistan’s 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, worker’s 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 Pakistan’s economy requires for sustainable growth.”