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Kardar decides to bat on an uneven wicket

February 11, 2014
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ASAD RIZVI

(September 14 2010): Shahid H. Kardar is well known figure in the business community for his analytical views on a variety of issues in relation to economics and finance. He is seen quite often on TV talk shows, providing objective analyses to viewers on issues ranging from central bank’s monetary policies to National Finance Commission Award.

Now he will be required to emphasise to the government in particular the power of economic tools that he has spent the past several decades learning. Indeed, a real test of his skills. So Governor Kardar, welcome to the real world of real economy, real finance and real GDP.

Before proceeding further, I seek to focus on the era of three pervious SBP Governors over the last ten years. The claim of growth shown during this period is tremendous in size – jumping from USD 60 billion to current roughly USD 172 billion. I am still not sure how we managed to arrive at such a huge number, because during this period we grew at an average of little over 6 percent, a growth pattern which has been fully endorsed by the SBP.

Dr Ishrat Husain (SBP governor from 1999 to 2005) was applauded for introducing reforms in the banking sector. He is said to have played a vital role in striking a delicate balance between growth and inflation. He helped bring macroeconomic stability through reduction in fiscal deficit. He also played a key role in helping the country acquire a surplus in balance of payments. Net outcome of the overall reforms was that the profit of the banking sector rose sharply.

Return on asset rose from negative (0.2%) to 2 percent and return on equity from negative (3.5%) to above 20 percent. Factors that helped were due to a rise in earning asset of commercial banks by 75 percent and the rise in advances to total assets by another 5%. He cashed in on the opportunity thrown up by 9/11, as home remittances, which were hovering around USD 1 billion annually, started to flow at a much faster pace, through banking channels, due to anti-terrorism filters in place. In 2001, SBP’s autonomy was limited, our monetary policymakers with the blessings of Shaukat Aziz, the then Finance Minister, who later became the Prime Minister opted for a very looses interest rate policy, setting a platform for the introduction of aggressive consumer culture. Discount rate, was reduced to 7.5 percent by November 2002 from 14 percent, supposedly to give a jumpstart to the stagnant economy.

World over loose monetary policy was the norm. Federal Reserves under the then Chairman, Alan Greenspan, allowed the discount and FED rate to fall below 1 percent from December 2001 till November 2002. By September 2003, Pakistan’s 6-month T-Bills Yield lowered to 0.92 percent and 10-year PIB to 3.93 percent; while US Treasury was at 3.98 percent. And Pakistan’s PLS rates fell to an all time low.

Another factor that was igniting quantitative inflation was the availability of cheap liquidity. SBP stopped dollar inflow of sterilisation accompanied with mop-up of excess rupee liquidity. Instead, SBP preferred to go for dollar/rupee buy/sell swap activity with a view to building-up foreign exchange reserves. Unfortunately, however, this continuous SBP swap activity resulted in creating excess rupee in the domestic market. This imprudent monetary policy greatly discouraged savings with average PLS rates for the first time nose-diving to an all time low of below 2 percent. It also triggered the widening of banking spread. Banks were offered minimal return to the depositors while average lending rate was above the 7.5 percent discount rate (Kibor was introduced in February 2004).

With negative return to depositors the savings to GDP ratio sharply came down from 16 percent in 2000 to 9 percent at present. In order to keep the fiscal deficit within IMF agreed targets, the Ministry of Finance discontinued sale of Pakistan Investment Bonds (PIBs) for almost 1 1/4 years and opted for T-bill auction only. As a result, the government’s borrowing profile shifted from a balanced long-term to a perilous short-term which, in the process, dealt a serious blow to the development of domestic debt market. All above factors cumulatively and profoundly contributed in promoting future inflation, which in the later years became a big monster.

In 2006, Dr Shamshad Akhtar was appointed Governor SBP. She served at the helm of country’s central bank for 3 years. By the time she took over inflation had spiked to 9 percent in 2006 from 5.5 percent in 2005. She was considered by the business community as a hardliner due to her hawkish monetary policy stance, although she had tried, albeit unsuccessfully to match the pace of inflation through her discount rate policy.

In 2007, she introduced another major banking reform. She placed a ceiling on foreclosures valued at 30 percent and forced banks to take cash provisioning. That meant no hiding and a shift of profits from dividends. This is one of her major contributions to the banking industry. Bank’s balance sheets now look healthy and well protected and can withstand the pressure of growing NPLs that have touched Rs 473 billion.

A number of banks perhaps owe their present-day existence to this key reform. Commercial Banks’ (local) capital is roughly Rs 550 billion. NPLs’ provisioning requirement after 180 days is another good step that is reaping positive results. Another brave move by her was placing of floor on PLS, which requires all banks to pay a minimum of 5 percent on PLS. But this step is not enough to encourage the depositors. She did not succeed in reducing the commercial banks advance to deposit ratio, which is a major factor for liquidity constrain. It is also causing a rise in NPLs.

Her decision to help the Musharraf government facing an election by maintaining the rupee-dollar parity constant and allowing the forex reserves to come down on account of rising oil prices instead of passing the cost to the consumers resulted in a big surge in inflation and a quick fall in the value of rupee against US Dollar – which lost 30 percent of its value in a span of 12 months (January 2008 to December 2008.) This was also a negation of her tighter policy stance she tried to adopt.

Syed Salim Reza became Governor SBP in January 2009 and resigned in June 2010. Business community welcomed his appointment in a hope that he will meet their demand of a cut in discount rate and he obliged them. He took appropriate decision by rationalising Dr Shamshad Akhtar’s earlier circular that required banks to fast track and take the paid-up capital of Rs 23 billion in an era of a economic slowdown. Banks are now required to maintain a paid-up capital of Rs 10 billion by 2012. His short tenure will be remembered for home remittances reaching an all time high of over nine billion dollars.

During his tenure, however, economic growth remained sluggish; in fact conditions deteriorated. Excessive government borrowing and fiscal indiscipline despite an IMF programme removed the norm and inflation continued to inch up. Circular debt and liquidity continued to pose a serious challenge to the country’s economy. Shaukat Tarin as the Finance Minister, he was effectively insulated the State Bank against political interference. But once Tarin was gone, he found himself unable to take this pressure. He, therefore, opted to leave prematurely.

Salim’s successor, Shahid Hafiz Kardar, is also facing numerous challenges: political, social besides economic issues. Floods have only added to the list of woes. The matter of immediate concerns are sluggish growth, surging inflation and constant government borrowing. Pakistan’s commitment to IMF to boost taxes, implement either an integrated VAT or a reformed GST and further raise electricity prices. SBP Governor’s assignment is a senior position in policy making. So far Kardar has been a consultant and a critic. Now he would be required to conceive, plan and execute. This requires accurate sequencing of reforms and priorities. He will have to articulate a strong and viable relationship with political forces in order to achieve the ultimate goal. Circular Debt and Fiscal Deficit are two other major issues that require co-ordination between Central Bank & MOF. In Pakistan, the Central Bank boss is also required to do lot of interfacing with Stock market.

The pace of growth in Microfinance sector and Islamic banking needs to be quickened. Poverty rate is surging fast and growth may get a setback due to slow growth in agriculture sector. Therefore, innovative business models need to be introduced, which should reach out to larger segments of poor population. Industrial growth may also remain below average, due to higher borrowing cost, energy and water crises. Monetary management would be the key challenge for Kardar. Strict legislation is required to curb borrowing from SBP and do away with the outstanding stock. But this is going to be extremely tough unless tax-to-GDP ratio is significantly and appreciable raised. All eyes will be on the introduction VAT. A big slash in expenditure cannot be avoided. Fear is that Fiscal deficit may creep up beyond 7 percent if the country is unable to get cash funding from overseas. Inflation is the biggest fear in the coming months and the tough decision for the policy makers would be hiking of Discount Rate, which is no more sustainable for our economy. The other factor that could cause another dent on the economy is a possible increase in import of food items and some of the other essential items, to meet the domestic demand. Whereas, some of the export items that Pakistan export such as Irri-9 may not be available due to floods. All eyes will also be on the global oil price, a surge beyond dollar 80 per barrel could bring more misery. Hence, unless Pakistan receives cash funding from donors and Friends of Pakistan, balance of payment position could further deteriorate. FDI and Bonds are no more an easy proposition and any widening of trade gap would inflate current account deficit, which would ultimately put pressure on the exchange rate. The recent interaction between President Zardari and the CEOs of the banks and DFIs need to be thought through. Immediate task for the new Governor SBP would be to co-ordinate with the financial institutions and explore funding opportunities for farmers affected by floods. Mere relaxation of provisioning rules will not do. Debt moratorium and interest write-offs and timely availability of money for procurement of seeds and fertiliser may be more appropriate.

The President has asked DFIs to prepare feasibility to launch Long-Term Infrastructure Bonds for rehabilitation and reconstruction of flood affected areas.

This may require very close co-ordination with Securities and Exchange Commission of Pakistan (SECP). The primary responsibility of DFIs is to provide long-term financing and therefore, their portfolio of asset/liquidity should be in long term. Asset creation should be for a minimum of two years and beyond. They are not supposed to be active market player on interbank market for overnight Repos or T-bills, short-term paper or for investment in Pakistan’s equity market. Therefore, discontinuation of discount window is recommended. Some of the large DFIs have 20 percent of their portfolio in stock market. They have no right to be on the short end of the market and instead they should be active in project financing. If SBP does not bar DFIs from short-term activity, there is every possibility that President’s effort will go in vain.

Copyright Business Recorder, 2010

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