The State Bank blinks

By Khurram Husain | 12/20/2012

I don't like people who say `I told you so.

Finger-wagging, hindsight nannies I like to call them. I find them just as annoying as anybody else does. Which is why I`m going to say this only once: I told you so! A year and a half after the State Bank began aggressively cutting interest rates under the guise of promoting `growth and investment`, they`ve finally come around to acknowledging something I`ve been saying all along about these rate cuts: the only beneficiary is the government.

In fact I went a little further. I actually argued that the intended beneficiary was also the government, that these rate cuts were not about `growth and investment`, that that phrase was nothing other than public relations spin.

And now 16 months and four percentage points later, we have this line in the monetary policy statement: `fiscal borrowings from the banking system continue to remain the main source of monetary expansion.

Translation: `we cut rates in the loopy hope it would give a boost to the private sector, and instead the government ate up all the cheap money that we made available.` I told you so! There is no mention of `lazy bankers` any more. The statement notes a contraction of Rs39.6 billion in the utilisation of private-sector credit, a state of affairs described by the authors as `not encouraging` but gives the reasons behind this dismal situation in this squeamishly constructed sentence: `expected support to the SBP`s initiative in the shape of improvement in the availability of energy and reduction in fiscal borrowing needs has not come through yet.

Talk about walking on eggshells. The words `not come through yet` are worthy of a standing ovation in the `understatement of the year awards`, when you consider that they are referring to the large-scale failures of the government in crucial areas like tax reform and energy. When the State Bank has to tiptoe around any mention of the government`s massive policy fail-ures, you know that political compulsions are speaking softly, but carrying a big stick.

The statement is couched in a chastened tone. For the first time the State Bank acknowledges that its policy of cutting interest rates carries risks for the exchange rate. As inflows have dwindled and debt repayments have climbed, the reserve position of the country has deteriorated, with reserves falling below the crucial $10bn level in October.

`The overall stress in the external position is increasing,` says the statement, leading to a 3.3 per cent depreciation in the value of the rupee since July.

`This stressed external position has implications for the rest of the economy. For instance, the decline in foreign exchange reserves is causing contraction in rupee liquidity. A depreciating currency is also affecting the size of the outstanding external debt in rupee terms and thus has implications for the fiscal position. Moreover, the magnitude and speed of pass through of exchange rate changes to CPI inflation need to be monitored closely in these circumstances,` say the authors.

So let me get this straight.

Declining reserves are putting a strain on the banks, causing our external debt service obligations to swell and eat up even more precious fiscal space, and darkening the outlook on inflation? And you guys only just discovered this now? Where was mention of these stark risks in the August monetary policy statement, which merrily cut the discount rate by 150 basis points? Were the guardians of the country`s reserves the only people around who did not know that the `overall stress in the external position is increasing` as late as August? We are entitled to ask whether or not the question of this risk was raised and debated during the board meeting that decided the August rate cut. Did the State Bank`s own monetary policy committee debate this risk? And on what reasoning did they decide to go ahead and run the risk of a rate cut in spite of a stressed external position? A lower interest rate affects the `return on rupee-denominated assets relative to foreign currency assets` and this consideration `is important and puts a natural limit on downward adjustments in the interest rate`. This merits a good round of applause.

Having discovered the obvious, perhaps the bank should now make clear to us how it intends to calculate this `natural limit` and how it views the prospects of a sustainable revival of foreign inflows for the remainder of the fiscal year? But let`s cut the bank a little slack. I mean, this cup isn`t entirely half empty. It`s a good thing that the bank has finally discovered our `stressed external position` and its relationship to the discount rate.

It`s also a good thing that the bank has decided to stop growling at the government`s creditors.

I have no love for the creditors, but it`s a primitive sentiment for a heavily indebted sovereign to start faulting his creditors` terms. The way out is tax reform, not cheaper credit, and it`s a good thing that the State Bank is starting to put its emphasis back where it belongs.

So should we now expect that the rate cuts are over and done with? Now that inflation is expected to stay at the targeted 9.5 per cent, and the external position is likely to stay stressed, and the fiscal equation is unlikely to change, is there any way left for the central bank to start contemplating further rate cuts? If so, I`ll look forward to reading the reasoning they give for their change of heart.
The writer is a Karachi-based journalist covering business and economic policy.

khurram.husain@gmail.com