Critical Analysis Of Pakistan Monetary Policies For Years 20102011 & 2011-2012

Submitted To:
Sir Ahmad Imran Khan

Submitted By:
Wajeeha Hasnain BB-09-066 B.B.A (Hons) 6th Semester Section-2

If saving money is wrong, I don't want to be right!

Historical Background
Monetary policy is what central banks use to manage the amount of liquidity in the economy. Liquidity is the total amount of money, including cash, credit and money market mutual funds. The important part of liquidity is credit, which includes loans, bonds, mortgages, and other agreements to repay. Central banks, including the Federal Reserve, manage the money supply to guide economic growth. Monetary policy rests on the relationship between the rates of interest in an economy, that is, the price at which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus influence the interest rate (to achieve policy goals). The beginning of monetary policy as such comes from the late 19th century, where it was used to maintain the gold standard.

Definition
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability.

Types of monetary policy

The distinction between the various types of monetary policy lies primarily with the set of instruments and target variables that are used by the monetary authority to achieve their goals.

Inflation Targeting Price Level Targeting Monetary Aggregates

Fixed Exchange Rate Gold Standard Mixed Policy

INSTRUMENTS OF MONETARY POLICY

Fiduciary or paper money is issued by the Central Bank on the basis of computation of estimated demand for cash. Monetary policy guides the Central Banks supply of money in order to achieve the objectives of price stability (or low inflation rate), full employment, and growth in aggregate income. This is necessary because money is a medium of exchange and changes in its demand relative to supply, necessitate spending adjustments. To conduct monetary policy, some monetary variables which the Central Bank controls are adjusted-a monetary aggregate, an interest rate or the exchange rate-in order to affect the goals which it does not control. The instruments of monetary policy used by the Central Bank depend on the level of development of the economy, especially its financial sector. The commonly used instruments are given below. Reserve Requirement Open Market Operations Lending by the Central Bank Interest Rate Direct Credit Control Exchange Rate

Analysis of Monetary Policy 2010-11

State Bank of Pakistan (SBP) on cut its key policy rate by 150 basis points to 12 percent citing a decline in inflation and government borrowings, it said in a statement. The central bank said it cut its policy rate by 150 basis points as it was taking some comfort from declining inflation and high probability of meeting the FY12 inflation target together with a need to support private sector credit and investment g rowth.

In September 2010, annual consumer inflation was 10.46 percent, compared with 11.56 percent in August 2010, and 13.77 percent in July2010, mainly due to a high base effect, which is to last through December. Although inflation had risen month-on-month by over one percent. However the central bank said there was a high probability that Pakistan would meet its target of average inflation at 12 percent for 2011/12 fiscal year. SBP raised rate by 50 basis points in November 2010, and held it steady until it slashed it by 50 basis points to 13.5 percent on July 30, also exceeding analyst expectations. The decline in government borrowing from the central bank was also one of the reasons for the rate cut, the SBP said. According to provisional data, the outstanding stock of government borrowings was 1,051 billion rupees ($12 billion) on Sept. 30, lower than the agreed limit of 1,155 billion rupees ($13.22 billion) for the fiscal year 2011/12. (Reuters)

The announced Monetary Policy of 2010 State Bank of Pakistan depicted no positive points, no hopes and no remedial measures. It said budget deficit target may be missed; government borrowing is increasing in 4QFY10, making the country more indebted. The key indicator of inflation, consumer price index (CPI), increased to 13.26 percent in April and was up 1.73 percent year-on-year. Therefore, to control rising inflation and widening fiscal deficit the policy discount rate will remain at 12.5 percent for the next two months. The rate was also not changed in the previous policy, announced on March 27. The bank expects that in 2009-10 the CPI will be between 11 to 12 percent. One of the main reasons of high inflation was a fall in productivity. The government may not be able to achieve 2009-10 budget deficit target of 5.1 percent of GDP. Thus, the objective of macroeconomic stability would also be a difficult target to achieve. The policy said the economy is recovering, but it lacks the required infrastructure and fiscal weaknesses are preventing macroeconomic stability. Besides, the worsening power crisis has hampered the growth of economy. In spite of increase in exports, over $1.8 billion in the last two months, supported by workers remittances and helped by the realization of $656 million from the Coalition Support Fund (CSF) in May 2010, the current account deficit would be about 2.5 percent of GDP for FY10.

Pakistan received $944 million in the last six months, with a total disbursement of $1.293 billion under the head of CSF during the current fiscal year. The reimbursements intended to aid in Pakistans fight against terrorism and restore stability in Pakistan and in the region. The bank was also concerned about the uncertain official foreign flows and declining Foreign Direct Investments (FDI). Thus, despite a significant reduction in the current account deficit, $3.1 billion during July-April, FY10, SBPs foreign exchange reserves remained around $11.5 billion on average during the current fiscal year. With an expected export and import to GDP ratios of 10.5 and 17 percent for FY11, keeping SBPs foreign exchange reserves stable without a discernable increase in financial inflows would be a challenge. After an outflow of Rs 150 billion in FY09, the NFA showed an inflow of Rs 90 billion during July 1May 14, FY10, that eased market liquidity. Inflation, which peaked to 25 percent in November 2008, came down to around 8.4 percent by end April 2010. The government surpassed its limits of quarterly borrowing from SBP by about Rs30 billion, in Q3-FY10. Since the beginning of Q4-FY10, borrowing has increased by another Rs 180 billion, reaching Rs 1,310 billion on 14 May, 2010, against the end-June target of Rs 1,130 billion. Similarly, government borrowing, net of deposits, of Rs 206 billion from scheduled banks during July 1May 14, FY10, also worried the bank. The borrowing from the banking system for budgetary support coupled with expected borrowings for commodity operations in Q4-FY10 is jeopardizing the space for private sector credit, causing inertia in market interest rates, running the risk of excess domestic credit creation and increasing the debt burden of future generations, the report indicated.

The bank advised the government to expand its income by expanding its revenues. The FBR tax collection, during the first ten months, was Rs 1,026 billion while the yearly target was Rs 1,380 billion. This means that a collection of Rs 354 billion was required in the last two months of the fiscal year. This amount is quite difficult to collect, as monthly

average was Rs 102 billion in the last ten months. Even if the target is met, the FBR taxGDP ratio is likely to be less than 10 percent, which is one of the lowest in the world. Difference between total revenues and current expenditure might cross 2 percent of GDP in FY10 (FY09: 1.5 percent of GDP), which will be incompatible with the objectives of macroeconomic stability. The bank advised the government to take necessary measures to increase the taxGDP ratio and reduce the current expenditures. Total revenues and current expenditure must be brought down to zero as stipulated in the Fiscal Responsibility and Debt Limitation (FRDL) Act of 2005. Moreover, the population is growing and cities are expanding that need investment in infrastructure, but government aims to cut development expenditures, which would severely affect the prospects of developing infrastructure including electricity generation and human capital development. This will reduce productivity and increase inflation as the gap between aggregate demand and supply would widen. All inflation indicators, including Consumer Price Index (CPI), Wholesale Price Index (WPI), Sensitive Price Index (SPI), Non-food Non-energy (NFNE), or trimmed measures of core inflation, have shown an upward movement in recent months. The policy said increase in electricity and petroleum products prices, a fall in productivity and volatile movements in various food items have fueled inflation that must be checked to improve the prospects of sustainable economic growth. The policy indicated that the cumulative growth of 4.4 percent in Large Scale Manufacturing (LSM), achieved during July-March, FY10, is encouraging but depends on supportive growth in private sector credit and improvement in the availability of electricity. The former would be difficult to achieve without reduction in the scale of fiscal and public sector borrowings from the banking system and the latter requires forward looking infrastructure investment and resolution of energy sector circular debt. Moreover, since the financial inflows are expected to remain heavily skewed in favor of borrowings, sustainability of external debt would require a manageable current account deficit and dependable financial inflows.

Analysis of Monetary Policy 2011-12

The State Bank of Pakistan (SBP) cut its policy rate by 150 basis points (bps) to 12 percent, marking a significant shift in monetary policy focus, which is a favorable step for the private sectors credit keeping in view the high inflation and expansionary fiscal policy over the last two years. The Debt Policy Statement 2011-12 has hinted that the government will be forced to continue borrowing from the State Bank of Pakistan (SBP), which will not only be inflationary but also complicate management of monetary policy and keep the domestic interest rates on the higher side.

Debt strategy contained in the Debt Policy Statement 2011-12 reveals that with a view to improve the quality of debt management operations, government, for the first time, adopted a comprehensive debt management strategy for fiscal year 2010-11. The key focus of the strategy was to; explore foreign currency borrowing avenues, and augment the domestic liquidity.

Quantitative targets, external sources; $500-1,000 million from international debt capital markets: The government issued a request for proposal to raise $500 million through issuance of exchangeable bonds of Oil and Gas Development Company Ltd and a consortium of leading international institutions was assigned the task, however the government did not get a favorable response from the international capital markets owing to euro zone credit and debt crises and general risk averseness on part of investors for sovereign debt and equity linked structures. The State Bank of Pakistan (SBP) has decided to keep the policy rate unchanged at 12 percent for the next two months after considering the need to revive growth and due to emerging risks to macroeconomic stability. To promote competition in the banking system and to offer alternative sources of savings to the population, the SBP has been encouraging depositors to invest in government securities through Investors Portfolio Securities (IPS) accounts, the SBP said in its Monetary Policy Decision. It said the option of maintaining saving deposits or investments in IPS accounts could provide stiff competition to banks forcing them to offer better returns on deposits. This in turn would incentivize savings and help lower the currency in circulation, it added. Moreover, it will improve the transmission of monetary policy changes to market interest rates, SBPs monetary policy decision said, adding that over time this strategy would also diversify the governments funding source, deepen the secondary market of government securities, and facilitate the issuance of corporate debt.

The End!