Sovereignty lies with IMF: An addendum
The Dec 12, 2021 MPC will determine kis ka koonda niklay ga: banks ka ya Shaukat Tarin ka
SBP’s holding a monetary policy committee (MPC) today. The MPC will decide whether to leave the policy rate unchanged or to increase it to “control inflation” read “overheating economy”. We have talked a lot about Econ101 here, where we were taught that inflation can be controlled by increasing the interest rate. We know that only demand-pull inflation can be controlled by increasing the interest rate. Both SBP and the PM have told us on different occasions that inflation in Pakistan isn’t demand-pull. There is a meme to go with it too.
But assuming that SBP goes with the argument that this truly is demand-pull inflation (a questionable claim at best), let’s look at the SBP data.
The below chart shows that credit to the private sector has been steadily increasing. The rate of increase is exaggerated, as the index on the left doesn’t start from zero. It appears that there were major increases in Dec 20, Jun 21, and Sep 21. The first two appear to be temporary, as they are in the shape of a kink i.e. followed by a decrease in credit outstanding. The Sep 21 increase is unusual as it isn’t followed by a decrease in credit.
In this post, we will try to answer if the September 2021 increase indicates a general loosening of credit, which is forcing SBP to increase the rates to curtail further increase.
Looking at private sector credit outstanding on a yearly basis, the increase in 2021 does appear to be rising rapidly compared to 2020 and 2019. The increase in credit outstanding between Oct 2021 and Jan 2021 is 10%, which is fast compared to 2020 and 2019 where the growth rate for the full year was 5% and 4% respectively. However, it is on trend to meet the full year growth rate of 2017 of 16% but still is lower than 2018 growth rate of 21%.
However, if I look at growth between Jan 2021 and Aug 2021 (assuming Sep 2021 to be an outlier), the growth in credit outstanding is merely 3%, which isn’t a growth rate that should worry the central bank.
September is a quarter-end. Banks publish their balance sheet at the end of every quarter. Thus, at the end of every quarter, the relationship managers at the banks encourage their borrowers to borrow the maximum amount to make the financials of the banks appear better. Occasionally, borrowers oblige but repay the excess borrowing early in the next month.
You can see that in the below graph wherein the large borrowings at a few quarter ends are followed by repayment in the following month. I have circled those quarter-end surges and repayments. However, the September 2021 surge is an outlier as it is not followed by a repayment rather incremental borrowing in October 2021.
Additionally, the blue bars show that SBP’s concessionary financing is rarely paid down on a net credit basis, i.e. concessionary refinancing is becoming permanent capital. This is also obvious from the below chart where, in contrast to the market-rate loans (blue lines) which have kinks showing borrowings and repayments, concessionary financing facilities outstanding (green line) continue to increase steadily (no kinks). Whereas on one hand, SBP wants to follow a contractionary policy, on the other hand, SBP continues to supply concessionary financing facilities that are interest rate agnostic.
In the above graph, the index on the left starts from zero, unlike the earlier graphs. As a result, the September bump in market-rate financing isn't that remarkable __ the market-rate loans (blue line) aren’t going crazy despite the policy rate (red dotted line) almost halving from 13.25% to 7%.
The below table shows the increase in both types of facilities over the last 12 months. The total increase in market borrowing over 12 months is only 12%, 40% of which happened in September.
Anyway, (as I had some time to waste), I broke down the borrowing in Sep and Oct 2021 by sector as well as by type of financing. I am only focusing on those that had a major increase in September.
Below list explains the acronym in the below chart.
IF - Import Financing
LT - Long Term Financing
TERF/LTFF - SBP’s concessionary long term financing
WC - Working Capital Financing
ERF - Export refinancing (concessionary)
CF - Construction financing
What does the chart say?
Major borrowing (the first four columns) is by the textile sector. If there is overheating, it is in the textile sector.
The largest component of textile borrowing is import financing. Not only was September's increase in textile import financing the highest compared to other borrowings in September, but it was also followed by even higher borrowing in October.
Is it due to the import of cotton or other raw materials by textile businesses in September and October? I am not a textile expert and didn’t have the time or energy to become an expert overnight by googling. This is left as an exercise for the reader to figure out what is causing the increase in textile import financing in Sep and Oct.
The thing about Import financing is that it is a liquidating facility (in contrast to concessionary facilities), as shown by the next three columns i.e., veg/animal oil and fats, fertilizer, and refined petroleum. Whatever was drawn in Sep 2021 in these three categories, most of it was paid back in Oct 2020.
The other major import financing was in power generation, which further increased in Oct 2021. That increase could be due to higher power generation requirements or higher-priced fuel imports.
The next big items are import financing of steel and construction financing of residential and non-residential. I have issues with how SBP calculates construction financing, but if SBP is making a major push for construction, this increase in financing for the construction sector including steel shouldn't bother SBP.
The other big financing item was long-term financing by telecom.
The only business that SBP may want to affect with interest rates is the wholesale and retail import financing and working capital. However, it only comprised 7% of September net borrowing. Moreover, it goes negative in October, i.e. some net borrowings get repaid.
There you have it. Except for wholesale/retail borrowing, there isn't anything in the private sector credit growth that is scary. The borrowing is driven by textile and that too in import financing, which is a liquidating facility.
SBP has made it clear by issuing a clarification that it dislikes when op-ed writers question steps taken by SBP without providing alternate solutions. Fortunately, I am not an op-ed writer, so SBP’s rant wasn’t directed at me.
The question I have is
What is the underlying economic theory that compels SBP to increase the policy rate? Or is it that "fiercely independent" SBP is following the diktat of IMF of increasing the policy rate citing whatever justification it can come up with?
CAVEAT: Needless to mention, the aforementioned is based on the classification of loan and borrower type as per SBP reports and I have written many times how both SBP and commercial banks manipulate it to meet certain metrics.
An alternate theory is that both IMF and SBP are using this to impose fiscal discipline on Shaukat Tarin. The theory goes that by increasing the interest rate, SBP will increase the borrowing cost of GoP. This will result in a share of the GoP budget diverted from PSDP to pay higher interest costs.
Unfortunately, this theory isn’t taught in Econ101. It is only learned at the school of dogma known as IMF.
The previous auction resulted in the national exchequer bearing an additional cost of Rs.666M. This Rs.666M will be coming from Government’s budget and will be going towards the commercial banks’ bottom line.
How much will this SBP tactic, if one can call it a tactic, would cost the Government of Pakistan?
The 6M auction amount is the same as was planned for November 18 i.e. Rs.111 billion. But now GoP will be paying 1.2% extra on this amount (11.5%p.a. instead of 10.2% p.a.)
Thus, GoP will be paying Rs.666 million (Rs.111 billion x 1.2% for 6 months) as an additional interest expense to the commercial banks.
Any other time and this would be scandalous considering that one, there was no reason to bring forward the MPC, and two, there was no reason to reject the bids if the plan was for an unexpected rise in the policy rate.
The next auction is a major one. Depending on who blinks first, either
banks ka koonda niklay ga, ya phir Shaukat Tarin ka
Much fun will be had after the next auction (someone might even get the boot) when we calculate how much did the SBP’s policy rate increase cost GoP in incremental interest costs and how much the banks’ already record-breaking profits will further increase on the back of it.