In July 2024, Pakistan’s money supply took an unexpected turn, as the State Bank of Pakistan (SBP) reported a slight contraction in total money supply (M3). This shift signals a change in the economic landscape, as the growth trend observed in the previous months has been interrupted. Despite this monthly decline, the broader picture still shows significant year-over-year growth, hinting at a more complex relationship between money supply, economic activity, and monetary policy.
In this article, we’ll explore the components of Pakistan’s money supply, the factors influencing its movement, and the broader economic implications of this contraction.
Money Supply Contraction in July 2024
The most recent data from the State Bank of Pakistan highlights a contraction in the country’s money supply for the first time in months. Specifically, the M3 money supply shrank by 1.04% in July 2024 compared to June 2024, settling at Rs39.2 trillion. This decline may seem small in percentage terms, but it represents a marked shift from the consistent upward trajectory seen in the first half of 2024.
Money supply, represented by M3, is an important measure of the total amount of monetary assets available in an economy at a given time. M3 includes not only physical currency but also deposits in banks and other liquid assets that can be quickly converted to cash. It provides a snapshot of liquidity in the financial system and can have far-reaching effects on economic activity, inflation, and monetary policy.
While the monthly contraction may raise some concerns, it’s crucial to consider this development within a broader context.
Year-on-Year Growth Remains Strong
Despite the slight month-on-month contraction, the money supply has still grown substantially on a year-over-year basis. Compared to July 2023, the total money supply increased by 14.63%, illustrating that liquidity in the economy has expanded considerably over the past 12 months.
This annual growth in money supply reflects broader economic trends in Pakistan, where increased economic activity, higher government spending, and rising remittances have contributed to greater liquidity. The rise in money supply over the past year suggests that, despite short-term fluctuations, the long-term trajectory of liquidity in the economy remains robust.
Breakdown of Money Supply Components
The M3 money supply figure is composed of several different types of monetary assets, each playing a distinct role in the economy. Here’s a closer look at the components of Pakistan’s money supply as of July 2024:
- Notes in Circulation: Physical currency in circulation stood at Rs8.95 trillion. This includes banknotes and coins used for daily transactions. While a substantial portion of the money supply, notes in circulation typically form a smaller part of the total compared to bank deposits.
- Transferable Deposits: Transferable deposits—funds held in checking accounts and other accounts that can be quickly accessed—make up the largest portion of the money supply. In July 2024, these deposits amounted to Rs21.15 trillion, reflecting the importance of banking system liquidity in the economy. These deposits facilitate everyday transactions and underpin a large part of the country’s economic activity.
- Other Deposits: Other deposits, which include savings and fixed-term deposits that cannot be immediately accessed, stood at Rs5.96 trillion. These deposits represent longer-term savings by individuals and businesses, contributing to the overall liquidity but with less immediacy in terms of spending.
- Coins in Circulation: The smallest component of the money supply is coins in circulation, which totaled Rs9.45 billion. While coins play a role in small transactions, their impact on the broader economy is minimal compared to other forms of money.
Each of these components interacts with the economy differently, and changes in one component can have ripple effects across the broader financial system.
Factors Influencing Money Supply
Several factors can influence fluctuations in the money supply. Understanding these variables is essential for grasping the implications of the recent contraction.
1. Monetary Policy
Monetary policy is one of the most direct ways in which the money supply is controlled. The State Bank of Pakistan manages the money supply by adjusting interest rates, conducting open market operations (buying or selling government securities), and setting reserve requirements for banks.
For instance, if the SBP raises interest rates, borrowing becomes more expensive, leading to a slowdown in economic activity and a reduction in money supply growth. Conversely, lowering interest rates can stimulate borrowing and spending, thus increasing the money supply.
The recent contraction in the money supply could signal that the SBP is tightening monetary policy to control inflationary pressures. Higher interest rates or more restrictive liquidity measures may have been introduced to slow down the pace of economic activity and reduce the risk of overheating the economy.
2. Government Spending
Government spending also plays a crucial role in influencing the money supply. When the government spends more, it injects liquidity into the economy, increasing the overall money supply. This can happen through infrastructure projects, social programs, or other forms of fiscal stimulus.
Conversely, a reduction in government spending can have the opposite effect, pulling liquidity out of the economy and potentially contributing to a contraction in the money supply. It’s possible that a slowdown in government spending during July 2024 contributed to the decline in M3.
3. Economic Activity
The level of economic activity is another key driver of money supply changes. When businesses are expanding, consumers are spending more, and the overall economy is growing, there is typically greater demand for money. This increased demand can lead to an expansion of the money supply, as banks create more loans and credit to support economic activity.
However, if economic activity slows down, as might have been the case in July, the demand for money decreases, contributing to a contraction in the money supply. A drop in consumer spending or business investment could reduce the need for loans and deposits, pulling liquidity out of the system.
4. Foreign Exchange Reserves
Changes in foreign exchange reserves can also impact the money supply. An increase in foreign exchange reserves, typically from higher exports or remittances, can lead to an increase in the money supply as the central bank converts foreign currency into local currency. Conversely, a decrease in foreign exchange reserves, possibly due to increased imports or foreign debt payments, can reduce liquidity in the economy.
In July 2024, if Pakistan experienced a decrease in foreign exchange reserves, this could have contributed to the contraction in money supply by reducing the amount of liquidity available in the system.
Implications of the Contraction
The recent contraction in Pakistan’s money supply has several potential implications for the broader economy.
1. Inflationary Pressures
One of the immediate effects of a contraction in the money supply could be a reduction in inflationary pressures. When there is less money circulating in the economy, demand for goods and services may decrease, which can help to curb rising prices. If the SBP’s goal is to manage inflation, then reducing the money supply could be a deliberate strategy to achieve this objective.
In Pakistan, where inflation has been a persistent concern, a tightening of the money supply could help stabilize prices and prevent runaway inflation. However, the extent to which this contraction will impact inflation depends on other factors such as supply-side constraints, global commodity prices, and fiscal policy.
2. Economic Growth
On the other hand, a significant contraction in the money supply could hinder economic growth. If businesses and consumers have less access to credit and liquidity, it could lead to a slowdown in investment and spending. Reduced availability of credit might discourage businesses from expanding, hiring, or investing in new projects, which could stifle economic growth.
The SBP will need to carefully balance the need to control inflation with the potential impact on growth. A prolonged or severe contraction in the money supply could risk pushing the economy into a slowdown or even a recession if not managed properly.
3. Interest Rates and Monetary Policy
The contraction in money supply may prompt further adjustments in the SBP’s monetary policy. If the central bank is primarily concerned about inflation, it could raise interest rates to tighten monetary conditions further. However, if the contraction begins to hurt growth, the SBP may need to consider easing policy to support the economy.
The central bank’s policy decisions will likely be guided by a careful analysis of inflation trends, growth forecasts, and other economic indicators in the coming months.
Conclusion
The contraction in Pakistan’s money supply in July 2024 is a notable development that signals a shift in the country’s economic trajectory. While the year-over-year growth in money supply remains robust, the monthly decline could indicate that the State Bank of Pakistan is taking steps to manage liquidity and address inflationary pressures. The broader impact of this contraction on the economy will depend on a range of factors, including government spending, economic activity, and foreign exchange reserves.
As Pakistan navigates these challenges, the central bank’s monetary policy will play a critical role in shaping the country’s economic outlook. A careful balance between controlling inflation and supporting growth will be essential to ensure that the economy remains on a stable footing in the months ahead.
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