Economic policymaking is all about balancing competing considerations, and monetary policy adjustments are no exception. The reinforcement of a lax monetary stance by a further cut of 50 basis points in the central bank’s policy rate should be seen in the same light.

The State Bank of Pakistan has lowered its key policy rate from 10 to 9.5 per cent under a very complex economic environment where there was a case both for and against continuing a loose monetary policy stance. A consistent decline in inflation for some months had given the central bank enough room to go for further cut in policy rate amid remote fears of inflation rising again to double digit from 6.9 per cent recorded in November. And the need for boosting economic growth and creating more jobs had rather required continuation of a loose monetary policy.

But depreciating rupee, depleting foreign exchange reserves, expanding stocks of domestic credit and on top of all, statistical evidence of “muted supply of bank credit to private sector businesses (PSBs)” had raised a big question mark over the utility of monetary policy easing. Ongoing excessive government borrowing from banks to manage fiscal imbalances had also brought under question prospects of sustaining a lax monetary policy.

That SBP finally chose to reinforce its monetary easing stance by a symbolic rate cut of 50bps suggests that after weighing all the ‘competing considerations, (as described in the monetary policy statement (MPS), the central bank believes that uninterrupted monetary easing would eventually make the desired impact on the key variables of economy.

That is a welcome sign for not only businessmen but for all those who think that had the SBP kept the policy rate unchanged it could have been mistaken by the markets as an indication that the central bank too is losing hope in lifting up the economy through reduced financial cost of doing business. But the policy rate cut alone does not remove their worries, also shared wholeheartedly by SBP itself, over continued reluctance of banks to make net lending to PSBs.

Regardless of how much cheaper bank loans are now compared to when SBP began lowering its policy rate, the more important question for businesses is: are PSBs getting enough of these cheaper loans from banks to produce more goods and services at affordable prices? After all, the economy is not going to get a boost automatically by repeated policy rate cuts. (Data cited in the recent MPS shows that credit to PSBs has rather contracted by Rs39.6 billion in the first four months of the current fiscal year “with most of the contraction taking place in the manufacturing sector).”

Whereas the data itself is worrisome and also understandable is the concern the central bank has shown while citing it in the MPS what else is important to look at is whether multiple policy rate cuts since August 2011 had made any impact on banks behaviour in lending to PSBs as well as on effective lending rates.

SBP statistics show that the stock of net lending to PSBs rose from about Rs2344 billion in August 2011 to Rs2410 billion in October 2012 showing an expansion of Rs66 billion. Similarly, average fresh lending rate of all banks (minus zero mark-up and minus interbank) fell from 14.57 per cent in August 2011 to 11.92 per cent in October 2012 exhibiting a decline of 265 basis points within 14 months amidst a cumulative policy rate cut of 400bps during this period—from 14 to 10 per cent).

Whereas this contraction seen in banks lending rates during the course of an easy monetary policy is a proof that the pass-through of monetary easing on interest rates is not that bad, a very modest expansion in banks lending to PSBs shows where the weakness lies. Had there been a larger increase in banks lending to PSBs that would definitely been part of an overall much better impact of monetary easing on overall economic growth and job creation.

Bankers say, and the central bank also agrees with them, that one of the reasons for slower growth in lending to PSBs has been a slump in credit demand. But businessmen and independent analysts are of the view, and SBP also shares this concern, that banks over-investment in government treasury bills and bonds has been the main reason for their low lending to PSBs.

The latest MPS admits, though by implication only, that quite often the central bank has to even facilitate government borrowing from banks by injecting huge liquidity into the banking system. From the point of interest rate management such a practice impedes development of an effective yield curve—so necessary for facilitating savings and investments.

Some central bankers say that monetary easing even in the absence of enough net expansion in lending to PSBs, does not become ineffective at all. “After all, consistent monetary easing provides the markets a strong clue on future direction of interest rate movements and that helps in containing inflationary expectations,” said a senior central banker, adding that damped inflationary expectations along with improved agricultural supplies had played a role in recent decline in inflation.

Another benefit of continuation of lax monetary policy even without corresponding growth in lending to PSBs is the contraction in most inflationary borrowings of the government from the central bank. Whereas monetary policy easing has encouraged the government to borrow more from commercial banks at cheaper rates it has also enabled the government to retire the central bank’s debt.

Whether the government can continue this trend is debatable given still-large fiscal deficits amidst weak external inflows and the latest MPS also doubts it. But officials of Central Directorate of National Savings claim that increasing ability of the government to raise funds from non-bank sources (mostly through National Saving Schemes) would ease off pressure of fiscal deficits thereby enabling the government to bring its fresh borrowing from SBP to zero at the end of every quarter as is now required under the law. They point out that investment in NSS in less than six months of this fiscal year has already surpassed the full year target of Rs224 billion—thanks to launching of short-term saving certificates and students welfare bonds.

Perhaps the most difficult trade-off that the central bank is making in continuing with an easy monetary policy is in the area of exchange rate management. The rupee is depreciating in part due to loosening of monetary policy but largely because of shallow external inflows. What the recent reinforcing of easy monetary stance suggests, however, is that though the central bank is mindful of the impact of easing on rupee-dollar parity (that is seemingly one reason behind only 50bps rate cut instead of a bigger reduction) it also realises that a weaker rupee in itself has contributed to recent surge in export earnings (up 23.7 per cent) and decline in imports bill (of 2.4 per cent) in November this year compared to the same month last year. But the story does not end here. When the rupee sheds 100 paisa against the dollar it adds one billion rupee in the local currency cost of external debt payments of a billion dollars.

“That again is a reason why SBP’s resorts to heavy liquidity injections into money market ahead of government bills and bonds auction,” fathomed treasurer of a large local bank. “This helps in keeping the cost of domestic debt servicing from rising too fast as a reasonably liquid money market means enough participation of banks in bills and bonds auctions and subsequently enough room for SBP to reject demands for higher yields without undermining the government’s target for borrowings.”