The State Bank of Pakistan (SBP) released its latest report on the state of Pakistan's economy for the quarter October-December,2002 on 19-3-03.
Evidently, these reports contain the bank's analysis and point of view regarding the latest developments in the economy as also measures necessary to keep the economy on the right track.
For the same reason, these reports are read with interest in the country as well as abroad. It will enhance the image of the bank if these reports are brief, succinct and a compact piece for reading. Sentences and phrases used in these reports should be carefully chosen and weighed as to their import reflecting the analytical skill of the central bank. Their tenor should exhibit a scholarly and a learned approach to the issues discussed and analyzed.
There should be a clear difference between how an ordinary market analyst would view the unfolding developments and how an economist, equipped with specialized skill, would view them. Bulk of varied information and special articles may be of interest to researchers at large but for this the vehicle should be the State Bank's monthly Bulletin- a practice normally followed by central banks elsewhere in the world.
As a central bank, the SBP is a primary player in monetary policy for the country and monetary policy happens to be one of the major planks of economic policy for the management of the economy. Management of a central bank is rightfully expected to be knowledgeable about the difficult questions concerning the role of money and non-bank financial institutions in the economy and the inflation theory – two central issues of positive economics on which economic profession is quite divided – so that they are able to conduct monetary policy on the lines conducive to the achievement of socio-economic objectives.
The situation becomes rather regrettable when, not to speak of difficult questions such as the role of money in the economy, the management of the central bank appears to be innocent of even elementary knowledge of determinants of monetary assets and their components as also the influence of foreign exchange resource inflow on the balance sheets of the State Bank and the scheduled banks. Quotations from the publication in section-I below should be adequate to substantiate this statement. A few comments on these are given in section-II.
Section 1: A. In the latest quarterly report of the bank, the discussion pertaining to growth and determinants of bank deposits highlights following points:
a) On p.56, Table 6.2 lists the following, “five determinants of growth of bank deposits: i) cash remittances, ii) SBP forex purchases; iii) reserve money, iv) currency in circulation; and v) NSS net mobilization.”
b) “On face value, this relative slowdown (in growth rate of bank deposits) is puzzling given:
i) A sharp growth in reserve money. The SBP's increased foreign exchange purchases in Q2-FY03, to mop up rising remittances, and a portion of this was not sterilized.
ii) The rise in credit off-take. This should also have had a multiple effect on banking sector deposits.
The explanation lies in the higher (seasonal) increase in currency in circulation and the rising investments in NSS instruments.”
iii) “Moreover, since borrower typically deposit their funds with lending banks, institutions recording high credit growth would also be expected to witness stronger deposit growth, (p.57).”
B: The following quotation from State Bank News of June 16, 2002 is quite revealing: “The third misconception in the popular media is about the SBP's purchases from the kerb market and interbank market…. In 1999-00 and 2000-01 we made purchases of about $4 billion from the kerb market. So what in fact we were doing was that we were getting hold of the workers' remittances channeled through this market.
“Some of well-trained economists writing newspaper columns have also questioned as to what happened to Rs.240 billion generated by the purchase of this amount. Money supply has two components – Net Domestic Assets (NDA) and Net Foreign Assets (NFA). So when the SBP purchases from the kerb market, the NDA of the scheduled banks increase as a result of the deposit of the equivalent rupees in the bank accounts of kerb market operators.
“These deposits are then distributed by the money changers to the families of the workers. To the extent that they keep some of these amounts in bank deposits, there is some increase in NDA of the scheduled banks. But 66 percent of the remittances are estimated to be spent on consumption by the families of the workers.
“The equation in the case of interbank market is much simpler…In this transaction, the SBP's purchases simply decrease the NFA of the scheduled banks and increase their NDA due to receipt of rupees for settlement of the deal. With these purchases, while the NFA of the SBP increases, the overall NFA of the banking system remain unchanged. This does not change scheduled banks' overall quantum of monetary assets.”
Section II: The SBP's latest quarterly report devoted 12 pages, from p.37 to p.48, to the analysis of developments in money and credit. The monetary survey for the first half of FY03 and for the comparable period of FY02 is given on p.40. The monetary survey indicates determinants of growth in money. Keeping this discussion of money and credit in view, it is hard to understand the analysis of growth of scheduled banks' deposits in terms of their five major determinants quoted above in Section I. This innovation appears to be not quite apt.
This reminds me of an incident. A member of the National Assembly asked the government to explain why notes in circulation of SBP had gone up sharply during a short period of time. The head of the Research Department along with two senior officers of the department deliberated from morning till evening but failed to come up with reasonable explanation.
The reason was that they were working on overall monetary survey to explain the rise in currency in circulation. They did not take even half an hour to prepare the reply when they were asked to confine their analysis only to the balance sheet of the SBP, since notes in circulation were its liability. Thereafter the Research Department started preparing six statements of monetary survey: i) overall monetary survey: a) stocks, and b) flows for analyzing determinants of monetary assets; ii) accounts of the SBP: a) stocks and b) flows for analyzing determinants of reserve money; and iii) accounts of scheduled banks: a) stocks, and b) flows to analyze determinants of bank deposits.
The statement that rise in credit off-take should have had multiplier effect on banking sector deposits is incomprehensible. In practice, credit expansion by commercial banks leads to an equivalent increase in overall monetary assets and not entirely to increase in bank deposits. There is no multiplier effect involved here. The authors seem to be not clear about the concepts of 'money multiplier' and 'credit multiplier', the former being MA/RM (monetary assets/reserve money) and the latter NDA of banking system/NDA of SBP.
The statement that since borrowers typically deposit their funds with lending banks, institutions recording high credit growth would also be expected to witness stronger deposit growth, is a good example of wrong reasoning. This virtually means “to hell with deposit mobilization.”
In the recent past the State Bank has purchased foreign exchange in the kerb and inter-bank markets. To understand monetary impact of these transactions one needs to be familiar with how the purchase of foreign exchange brings about changes in a) balance sheet of the SBP; b) balance sheet of scheduled banks; c) Inter-bank transactions; d) level of monetary assets; and d) level and composition of reserve money.
Direct purchase from kerb market: In this case, sources of supply of foreign exchange are from outside the banking system. If the SBP purchases $100 million from the kerb market, NFA of the State Bank will go up by $100 million (Rs6 billion) and its rupee liabilities will go up by the same amount as it pays to the seller of foreign exchange through his designated bank, either by paying cash to the bank or by crediting its deposit account with the SBP.
As the designated scheduled bank would credit the account of the seller of foreign exchange to the State Bank with an equivalent amount since received from State Bank, there would be increase in monetary assets (M2) in the form of increase in bank deposits as well as increase in reserve money of the order of Rs.6 billion.