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Dynamics of macroeconomic stability and financial stability Dr. Shamshad Akhtar Governor State Bank of Pakistan January 14, 2008 Outline I. Conceptual Macroeconomic Framework and its Interrelationships II. Trends in Growth, Money and Prices III. Financial Trends and Stability 2 Saving-Investment Gap and CAB 1. GDP = C + I + X – M 2. GDPNI = C + I + [X - M + YF + TRF] CAB 3. GDPNIP + GDPNIG = CP + CG + IP + IG + CAB 4. GDPNIP - CP - IP + GDPNIG - CG - IG = CAB SP SG 5. [SP - IP] + [SG - IG] = CAB (or -SF) How Saving-Investment gap is financed? Private sector can finance through ― Net foreign borrowing ― Loans from domestic banking system ― Net foreign direct investment Government can finance the deficit by ― Borrowing from domestic banking system ― Selling bonds/bills ― Obtaining net foreign borrowings CAB and Money supply M2 = NFA + NDA So DM2 = + DNFA [BoP] D credit to government [Fiscal] + D credit to non-govt [Real] + D OIN Interrelationships Among Macroeconomic Accounts REAL SECTOR National Accounts Private consumption General government consumption Private investment General government investment Exports of goods and nonfactor services Imports of goods and nonfactor services CENTRAL GOVERNMENT Revenues Grants Expenditures Current Capital Overall balance Financing Domestic financing (net) Banking system Nonbanking sector External financing (net) MONETARY SECTOR EXTERNAL SECTOR Monetary Authorities Balance of Payments CURRENT ACCOUNT Exports of goods and nonfactor services Imports of goods and nonfactor services Factor services (net) Transfers (net) Official Private CAPITAL ACCOUNT Direct investment Medium/long-term capital (net) Short-term capital (net) Overall balance Change in net foreign assets Accounting identities Strong accounting relationships Net foreign assets Net domestic assets: Net credit to central govt.. Credit to banks Other items (net) Reserve money Deposit Money Banks Net foreign assets Banks' reserves Net domestic assets: Net credit to central govt. Credit to private sector Other items (net) Liabilities to monetary authorities Private sector deposits II. Growth, Monetary Policy and Inflation Dynamics Long Term Trends in Inflation and GDP Growth GDP 14.0 Inflation High Inflation 12.0 10.0 8.0 6.0 4.0 Low Growth 2.0 FY07 FY04 FY01 FY98 FY95 FY92 FY89 FY86 FY83 FY80 FY77 FY74 FY71 FY68 FY65 FY62 FY59 FY56 0.0 Note: the trends are for 10-year moving averages. 8 After a loose monetary policy stance from FY02FY04… SBP had to enter into monetary tightening phase SBP 3-Day Repo Rate 24 20 Loose Monetary Stance 12 8 Tight Monetary Stance 4 Dec-07 Mar-07 Jun-06 Sep-05 Dec-04 Mar-04 Jun-03 Sep-02 Dec-01 Mar-01 Jun-00 Sep-99 Dec-98 Mar-98 Jun-97 0 Sep-96 percent 16 9 Monetary stimulus played a significant role in growth revival… FY07 FY06 FY05 FY04 5-years average FY03 FY02 FY00 FY99 FY98 FY97 10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 FY01 Real GDP growth FY96 percent Real GDP Growth 10 Growth picked-up – however, with money supply growth outpacing nominal GDP growth CPI rose from 3.5% in FY02 to 9.3% in FY05 Inflation & Monetarty overhang Monetary overhang Inflation (rhs) 15.0 9.0 13.0 11.0 9.0 5.0 7.0 3.0 5.0 1.0 3.0 1.0 -1.0 -1.0 -3.0 FY07 FY06 FY05 FY04 FY03 FY02 FY01 FY00 FY99 FY98 FY97 FY96 FY95 -3.0 FY94 percent 7.0 11 Food prices are still a major source of volatility and recent price hike; tight monetary policy helped in arresting demand driven inflation as reflected in core inflation Trends in Inflation (YoY) Core (Non Food & Non Energy) 16 Core (20% trim) Food 14 percent 12 10 8 6 4 Nov-07 Sep-07 Jul-07 May-07 Mar-07 Jan-07 Nov-06 Sep-06 Jul-06 May-06 Mar-06 Jan-06 Nov-05 Sep-05 Jul-05 May-05 Mar-05 Jan-05 2 12 Several Monetary Policy measures have been taken to contain inflation since FY05 Changes in policy rate (i.e. SBP 3-day REPO rate): – from 7.5% to 9.0% in April 2005; – from 9.0% to 9.5% in July 2006; – from 9.5% to 10.0% in July 2007. Changes in CRR and SLR – Current CRR are: 7% for demand & time liabilities of less than one year; – Earlier CRR were 3% for time liabilities above 6 month maturity and 7% for demand and less than 6 months time liabilities; Aggressive liquidity management through OMOs 13 Monetary tightening partly diluted due to SBP refinancing schemes and high government borrowings; both issues addressed in FY08… Reserve Money Flows (cumulative) during FY07 Rise in NFA due to receipt of external financing by the government, though substantially sterilized 250 Rise in RM due to subsidized financing 200 100 50 0 SBP NFA Reserve money Jun May Apr Mar Feb Jan Dec Nov Oct Sep Aug -50 Jul billion Rupees 150 SBP NDA 14 Rising international food and oil prices remain key risk for FY08… While monetary policy is ready to contain demand pull inflationary pressures, cost push factors may pose threat to price stability in FY08. Among others, the key problems are: 1. Rising global commodity prices, in particular steep uptrend in international oil prices. 2. Domestic agriculture crops outcome (particularly wheat, sugarcane & gram) during FY07 was good. However poor demand-supply management has led to crisis situation in the country. 3. Rising per capita incomes, but shortages emerged because of fluctuations in productive sectors or problems with 15 distribution of commodities. Measures to further arrest inflationary trends… Besides increase in SBP policy rate, SBP recommended the government to retire SBP debt in FY08 (by Rs 62.7 billion) to ease reserve money growth Introduced policy to reduce commercial banks’ reliance on refinance facilities (envisaged a 30 percent reduction in outstanding refinance at end June 2007 during FY08 without affecting the overall availability of credit to the exporters). Stepping forward towards a more market based credit allocation mechanism the age old credit planning exercise has been abandoned completely. SBP has been encouraging long term paper issuance with regular frequency to transfer government reliance from SBP to private financing sources 16 Growing macroeconomic Imbalances are now posing renewed challenges July-November data reveals that both fiscal and external account deficit will be higher than original projections. Borrowing from central bank to finance budget is significant and such borrowing is likely to augment inflationary pressures since output will be impacted by the recent disruptions. The central bank will have to take appropriate measures to further contain demand pressures augmented by fiscal and external deficits. Extent of monetary tightening would depend on fiscal restraints. FINANCIAL SECTOR STABILITY Financial Sector is bank dominated… Composition of Financial Sector Assets Percent share in Assets 80 70 60 50 40 30 20 CY00 Banks CY01 CY02 CY03 CY04 CY05 CY06 Others 19 At present the banking sector is predominantly owned by private sector… Ownership Structure of the Banking Sector 90 70 60 50 40 30 20 PSCBs H1-CY07 CY06 CY05 CY04 CY03 CY02 CY01 10 CY00 percent of total assets 80 LPBs 20 Foreign stake is rising in Pakistan’s banking sector… Position of Shareholding 80 70 percent 60 50 40 30 20 10 0 CY04 Pakistani CY05 CY06 Foreign 21 Banking sector assets are growing rapidly… Assets of the Banking System 58 56 52 50 48 46 44 42 H1-CY07 CY06 CY05 CY04 CY03 CY02 CY01 40 CY00 percent of GDP 54 22 Encouragingly rapid growth is accompanied with improvement in asset quality… Banks’ Non-Performing Loans 25 20 10 5 Net NPLs to Net Advances H1-CY07 CY06 CY05 CY04 CY03 CY02 CY01 0 CY00 percent 15 NPLs to Advances 23 Increased capital requirement, with improved asset quality, has enhanced soundness of financial sector… Indicators of Capital Adequacy 16 14 10 8 6 4 CY06 CY05 CY03 CY04 Tier 1 capital to RWA H1 -CY07 CAR CY02 CY01 2 CY00 percent 12 24 Banks are well capitalized… Net NPL to Capital Ratio 160 80 40 H1 CY07 CY06 CY05 CY04 CY03 CY02 CY01 0 CY00 percent 120 25 Banks’ profitability has reached an all time high… After Tax Return on Assets 2.5 2.0 1.0 0.5 0.0 -0.5 H1-CY07 CY06 CY05 CY04 CY03 CY02 CY01 -1.0 CY00 percent 1.5 26 The 2.1 percent ROA during CY06 is significantly higher than the international norms of around 1.0 percent…. Table: Return on Assets percent CY01 CY02 CY03 Pakistan -0.5 0.1 1 Bagladesh 0.7 0.5 0.5 India* 0.5 0.8 1 Korea 0.7 0.6 0.2 Singapore 1 0.8 1.1 Thailand 1.5 0.2 0.7 SriLanka 0.7 1.1 1.4 source: Global Financial Stability Rports, IMF *ROA before tax CY04 1.2 0.7 1.2 0.9 1.3 1.3 1.4 CY05 1.9 0.8 0.9 1.2 1.2 1.5 1.3 CY06 2.1 N.A. N.A. 1.3 1.2 1.5 N.A. 27 Financial Soundness Index (FSI) witnessed that the performance of the banking system has improved substantially over the last five years…. Financial Soundness Index 1.2 0.8 0.4 0.0 -0.4 -0.8 H1-CY07 CY06 CY05 CY04 CY03 CY02 CY01 CY00 CY99 CY98 CY97 -1.2 28 Mutual funds are the fastest growing subgroups within NBFIs… Composition of NBFIs’ Assets 60 50 percent 40 30 20 10 0 FY02 FY03 Mutual Funds FY04 DFIs FY05 FY06 Others other includes Discounting, Housing finance, Investment Finance, Leasing, Modaraba and Venture Capital 29 Insurance penetration is increasing in a steadfast manner… Asset Structure of Insurance and Reinsurance Sectors 300 250 billion rupees 200 150 100 50 0 2003 Reins urance 2004 2005 Life 2006 Non Life 30 By now market capitalization has surged to 48.5% of GDP… Market Capitalization of Karachi Stock Exchange 50 45 percent of GDP 40 35 30 25 20 15 10 5 0 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 31 Banking Sector Growth complements KSE growth… June-06 March-07 Tech & Comm Cement Oil & Gas Exploration Oil & Gas Marketing 35 30 25 20 15 10 5 0 Banks Percent of market capitalization Banks have played a major role in the growth of the KSE-100 index by contributing more than 30 percent in KSE market capitalization June-07 32 Foreign participation in KSE is rising… 8 7 6 5 4 3 Dec-07 Oct-07 Aug-07 Jun-07 Apr-07 Feb-07 Dec-06 Oct-06 Aug-06 Jun-06 Apr-06 Feb-06 Dec-05 2 Oct-05 percent of market capitalization Foreign participation in KSE market capitalization has increased to 7 percent 33 Future Agenda Continued effective monetary policy conduct and management Macroeconomic stability prerequisite for financial sector growth Consolidation and growth in banking sector Introduction management of Basel II along with strengthening of risk Continued strengthening and improvement in governance structure of regulators Broaden and deepen financial sector reforms o Diversification of financial sector o Augmenting robustness of banking sector o Enhancing financial services penetration • Islamic banking • Microfinance Concluded 35 Some extra slides… Maturity Mismatches & SBP motive The maturity mismatched aspect has increased for banks operation in Pakistan during recent years. However, SBP has introduced tiered cash reserves requirements for demand and time liabilities to encourage banks to mobilize long term deposits. 28 26 10 7.6 15 5 0 -5 0.6 30 5 to 10 yrs 1 to 5 yrs 3-m to 1-yr Q2-CY07 Q4-CY06 Q2-CY06 Q4-CY05 Q2-CY05 Q4-CY04 Q2-CY04 Q4-CY03 Q2-CY03 Q4-CY02 Upto 3-m -10 24 Q2-CY02 percent 32 (9.0) percent of Assets 34 12.0 GAP Analysis -End June 2007 20 Asset Maturing After One Year 36 Proactive liquidity management has reduced volatility in short-term interest rates… SBP Policy rate and Overnight Repo rate in Interbank Market SBP Policy rate Average O/N rate Coefficient of variation 12 10 percent 8 6 4 2 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08* *: up to January 10, 2008 37 Responsiveness of private sector credit to lending rates has increased… Real Lending Rates and Private Sector Credit Gro wth in Private Sector credit Real lending rate 40 35 30 20 15 10 5 0 -5 FY76 FY77 FY78 FY79 FY80 FY81 FY82 FY83 FY84 FY85 FY86 FY87 FY88 FY89 FY90 FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 percent 25 Regulated interest rates Market based interest rates 38 FX Reserve Adequacy Reserves to Short FX Reserves* Import Coverage Term Liabilities FY00 1973.6 10.7 1 FY01 3231.6 16.5 1 FY02 6435.2 35.5 3.3 FY03 10769 49.3 7.6 FY04 12389 47.2 10.1 FY05 12598 35 8.6 FY06 13122 27.8 9.4 FY07 15634 30.2 7.8 8-Jan-08 15334.5 28.8 n.a *: Gross FX reserves including SBP and Scheduled banks Reserves 39