LAHORE: In less than three years, the central bank has changed its monetary stance three times from hawkish to dovish and back to hawkish. Is it the failure of the government or the central bank?
The present governor State Bank of Pakistan (SBP) has been very vocal in supporting policies by the current regime but, the volatility in the monetary stance shows that either the policies were not in the right direction, or the central bank failed to grasp the situation in time.
Every central bank desires foreign exchange reserves to rise and strives for a stable currency. Foreign exchange backs stable and emerging economies based on exports (or foreign inflows through investments). In the last three years, our central bank has tried many expensive ways to increase its liquid reserves.
During the times of high interest rates, the bank allowed foreign funds to invest in short term treasury bonds at prevailing domestic market rates.
Investors were allowed to take back their investment in dollars, including the interest paid on those bills.
It proved to be a lucrative deal for the investors who did not get even 10 per cent of the profit on their dollar investments in the global market.
At peak, the treasury bills purchased in dollars were over $3 billion which the central bank included in its foreign reserves.
Then came covid-19 and the interest rates were as rapidly slashed as were increased to attract the hot money.
The hot money evaporated with the maturity of the treasury bonds. The investors were not losers as they got all their dollars back with high interest. The lower interest rates were, however, not attractive for funds and the hot money inflows halted.
This was a set back to the efforts of the SBP, so it introduced another scheme. This time, it was for the overseas Pakistanis. They were lured to open dollar accounts in Pakistan and the central bank guaranteed a rate of return of seven per cent. This was seven times higher the interest that the depositors get on dollar accounts in other countries.
These Digital Roshan Accounts now have deposits of over $3 billion. The commercial banks that open these accounts are provided the entire markup by the central bank.
The markup provided is double the markup that Pakistan pays to its major creditors like China, Saudi Arabia, or UAE on their short-term loans. These deposits shore up the foreign exchange reserves.
It is interesting to note that the foreign exchange reserves have not been boosted through trade. In fact, in the last two quarters, we are losing more foreign exchange through imports that are more than 2.5 times our exports. The future looms as despite all these efforts, the rupee remained volatile throughout.
We are rapidly adding to our foreign liabilities as the foreign reserves continue to deplete despite regular infusion of foreign loans and the digital accounts.
The Digital Roshan Accounts are not technically foreign loans, but the deposits are a liability that must be cleared on demand in foreign exchange.
We might see the resurgence of hot money as the policy rates move up as indicated by the central bank as well (at least one per cent this fiscal).
The foreign earnings through exports would not rise appreciably or may probably slow down in wake of numerous measures taken by the government and the state bank. The gas rates of exporting industries operating in Punjab have been increased recently.
The gas tariff differential between the other three provinces and Punjab would widen to three times (over 50 per cent of exports originated from Punjab).
The central bank has increased the policy rate by 1.5 per cent at the top of an earlier increase of 0.5 per cent in the last monetary policy. It will increase the cost of borrowing for all.
At the same time, the cash reserves requirements of all banks have been increased from five to six per cent.
This will suck a huge liquidity of the banks. With increase in policy rates the commercial banks would be more inclined to lend to the government that is the largest borrower. It will crowd out credit for the private sector which experienced a recent surge in its credit appetite.
The higher interest rates are expected to increase the debt servicing cost of the state by an estimated Rs300 billion. This means consuming in all the surplus revenue that the Federal Board of Revenue (FBR) collected in last four months.
To generate more revenue, the state should announce new revenue measures. The price stability would be a forgone dream as we will experience cost push inflation. The rich may sail through with some grumbling but it’ll be a nightmare for the poor to survive each passing day.