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SBP autonomy and monetary policy – VI

The challenges facing the economy are deepening. As we pointed out last week, the main concerns of the central bank – government borrowing, policy rate and exchange rate – are under severe stress. Although the minutes of the last Monetary Policy Committee (MPC) meeting are not yet available, it is evident from the reading of the monetary policy statement (MPS) that the MPC is not fully alive to these challenges.

The state of the government borrowing is becoming precarious. The new data for 9th February suggests that the government borrowings from SBP stand at Rs 729 billion compared to Rs 983 billion for the same period last year. This comparison needs careful scrutiny. Last year the borrowing had a significant component on account of maturity of 42nd PIB auction with a bullet payment of Rs 1.3 trillion, which could not be refinanced except through a staggering of future issues of PIB. Hardly Rs 650 billion could be mobilized during the first half of FY17. Thus, a great deal of government borrowing of Rs 983 billion last year was not for financing deficit but for switching to smooth out an unusual build-up of PIB maturities.

The current level of SBP borrowings of Rs 729 billion coupled with the external borrowings (estimated at Rs 350 billion in the first half for balance of payments) and from national savings estimated at Rs 100 billion, shows the deficit at Rs 1179 billion that is way above the proportionate deficit for the first half. The estimate of deficit from net accumulation of debt is much larger, as reflected in the latest numbers central government debt, at Rs 1362 billion. What is more alarming, as we discuss below, almost all government borrowings so far are either from SBP or from external sources. Neither commercial banks nor ordinary public (national savings) are contributing to government borrowing.

The second issue is the policy rate. The recent action of MPC has not altered the disruptive behaviour in the government debt market. The MPS acknowledged the fact that exchange rate depreciation, rising oil prices, declining differential between domestic and foreign international interest rates, due to actions by several central banks, have had a bearing on the decision. However, the decision fell significantly short of achieving the desired result of containing the rising aggregate demand. The following factors have not been taken into account while making the decision:

First, the government debt market is completely disrupted. Since August 2017, not a single PIB auction has been successful. Not just that, maturities falling due during the period (at least one major maturity of Rs 500 billion in the first quarter) were financed through market treasury bills, (ie, SBP financing). Commercial banks are deleveraging from government paper, as nearly Rs 233 billion worth of debt of commercial banks were retired between 1Jul-9Feb.

Second, nearly the entire government borrowings from central bank are in three-month paper. With that, the refinancing and price re-fixing risks are rising as the share of domestic debt has sharply increased.

Third, the real reason behind the disruption in government debt market is the serious difference between prevailing rates and market expectations. In the six PIB auctions where all bids were rejected, the rates bid by the investors were higher by about 100bps. It is important to note that these expectations were building in the last six months. This information was available to MPC and cannot be disregarded for otherwise we are simply delaying the day of reckoning, which, the more it is delayed, more painful it would be. Besides, it is difficult to understand why the SBP would adopt an accommodating monetary policy at the risk of sacrificing its objective of setting policy rates to bring order in the debt and money markets.

Finally, the current account deficit remains stubbornly high and is projected to increase to 5% of GDP, compared to 4% last fiscal year. This would be the highest external account deficit in nearly a decade. An oil price shock, at this precarious stage would have a serious impact on balance of payments. This situation is indicative of high aggregate demand that would not be tamed by small measures such as a 25bps action of the MPC. Here again, the MPC action is not fully consistent with the role the monetary policy is supposed to play in stabilizing the economy.

We now turn to the issue of foreign exchange reserves that also falls within the responsibilities of the central bank. At the outset, let us consider how much reserves the country has lost since October 2016, when they touched the historic level of $24.5 billion (with SBP reserves at $19.4 billion). On 2 Feb 2018, the reserves were $19.2 billion, with SBP reserves at $13.1 billion. This shows that SBP has lost $6.3 billion in reserves during this period.

But there is another detail that one needs to keep in perspective. The external public debt as on 30-9-2016 stood at $58.7 billion which climbed to $63.4 billion as on 30-9-2017, adding a marginal burden of $4.7 billion in one year. Additionally, $3.0 billion have been borrowed for BOP support in the last quarter of 2017. The significantly diminished current level of reserves therefore has to be contrasted with major increase in external debt burden of $7.7 billion. Alternatively, we can say that the country has used $14.0 billion ($6.3 billion in loss of reserves and $7.7 in fresh borrowings) within 16 months to support the balance of payments. This gives roughly an average gap of $1 billion per month in current account that we are financing either by using our reserves or through fresh borrowings.(Note that this is an average, with the higher deficit occurring in recent months).

This is a dangerous situation. If there was any need to find a conclusive evidence whether the country was facing an unsustainable aggregate demand, this is it. We see not even months passing under the ‘business-as-usual’ framework. One may also ask what was being achieved by sacrificing such colossal amount of precious foreign exchange resources. Evidently, the so-called ‘exchange rate stability’. It is hard to find a justification for supporting the exchange rate at such high cost. The strategy has essentially created vulnerabilities that may pose grave dangers to economic stability when faced with a shock. Worse, with each passing day, the required adjustment, when it does come, would be more disruptive than what would be required with incremental adjustments as per the market conditions.

Viewed in this background, the MPC action of 25bps together with the isolated depreciation of 5% had had no impact in correcting the already developed imbalances. The time is running out and required actions must be taken without further loss of time.

Waqar Masood Khan, "SBP autonomy and monetary policy – VI," Business Recorder. 2018-02-14.
Keywords: Economics , Monetary policy statement , Monetary Policy Committee , Foreign exchange resources , Central bank , Government borrowings , Policy rates , MPC , SBP , GDP , PIB