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Monday, August 9, 2010

Monetary Policy: Who Is Responsible For Poor Economic Situation?

We are in a very unfortunate situation. A very simple economics tells us that Central Bank reduces money growth to curtail economic growth because too speedy economic growth will dry up the resources and that will induce the inflation.
In Pakistan, Central Bank has reduced money growth by increasing discount rate. Why? To curtail economic growth? Actually, we don't have a substantial growth. Last year (FY 2010) we achieved a growth rate of just 4.1 percent. While we compared this to our neighbours like India (8 percent) and China (9 percent) we are actually nowhere so why did Central Bank increase rate?
This can best be explained in points:
1. The Govt borrowing is exceeding it's limit and this borrowing is for Consumption purposes rather than Investment purposes.
2. Because of electricity shortages and poor law and order situation, the investment is very minimal. Therefore supply is limited and not increasing.
3. Govt borrowing is crowding out the private investment.
4. With no increase in supply, and continuous increase in Govt borrowing which is creating consumption led demand, inflation is increasing which is 12.7 percent for FY 10.
Therefore SBP has no option but to curtail this consumption led demand which will ease pressure on inflation.
This has been a story. As the above points clearly shows that Fiscal Deficit was the real problem. But the increase in interest rate will definitely slow our growth further which means this year we will see a growth rate much lower than 4.1 percent which imply poor economic conditions.
Who is responsible for it? Government? Surely it is. Government need to increase its resources from somewhere else like Tax. Remember Pakistan's Tax to GDP ratio is lowest in the world with around 8 percent. Government also needs to reduce corruption. The total Government borrowing from SBP in FY 2010 was 1,171 billion while the target was only 1,130 billion. The Government also borrowed Rs. 330 billion from commercial banks. So it left no money for private sector to borrow. Private Sector creates more jobs than Govt Sector. Private sector uses money more efficiently than Govt Sector. There is less corruption in Private Sector than Govt Sector. But very unfortunately Govt is borrowing all the money and the worse thing is that the Govt is not investing this money but most of this borrowing is to meet current expenditures (You can verify this by reading the monetary policy statement available on SBP website) which doesn't create jobs.
Surely, we got the answer. Who is responsible for this bad economic situation?

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