SBP to follow neutral and balanced monetary policy: fighting inflation not the sole objective

The State Bank of Pakistan has decided to shift from the accommodative to a neutral monetary policy stance during the next six months to suppress the current accelerating trend in core and non-food inflation, wring out inflationary expectations from the system and to discourage speculative and non-productive financing, while easing supply of loan-able funds to creditworthy corporations, individuals, farmers and SMEs at non-negative real lending rates.
The Central Board of Directors of SBP, which met under the chairmanship of Governor Dr Ishrat Husain on Wednesday, at the SBP Head Office in Karachi, has issued a Monetary Statement arguing that in a developing country like Pakistan, inflation in the range of 5 to 7 percent per se is not damaging for the economy since human capital and other factors of production are under-utilised.
Unlike it is in the developed world, SBP said, fighting inflation cannot be its sole objective and it would continue to pursue a policy aimed at higher economic growth, productive employment and capacity expansion, while continuing to attack inflation in a measured way by gradually tightening monetary policy and raising lending rates.
The central bank said it would remain alert to the movements in key monetary and credit variables and take corrective measures, if required, to maintain price stability. However, this would entail keeping a healthy balance between suppressing inflation and facilitating investment, growth and employment in a non-inflationary environment.
In effect, SBP said, food which constitutes 40 percent of the CPI and house rent another 23 percent, besides high international prices are the major supply side factors contributing to inflation, and the monetary policy can do very little to counter them.
The SBP Statement said that "the consumer price inflation which remained around 4 percent for the last few years shot up to 9.3 percent in July 2004. Nonetheless, it has come down to 8.8 percent in December 2004 due to receding food inflation.
The core inflation, on the other hand, is still heading upwards, though at a slow pace, and has risen to 6.8 percent in December 2004 from 6.1 percent in July 2004. The current increase in price pressures is likely to be arrested with the rising trend of interest rates.
In addition, there are at least six factors that may also weaken inflationary pressures and expectations during the remaining part of the year and these are: Robust growth in agriculture and industry;
Improved food supplies from additional wheat import;
Improved fiscal performance reinforced by sustained improvement in financial performance of PSEs;
Expectation of stable exchange rates with SBP's commitment to provide foreign exchange for imports;
Potential addition to exportable surplus resulting from record-high cotton production;
Weak wage pressures in the labour market due to high unemployment.
Simultaneously, said SBP, inflationary expectations are likely to remain for at least four key reasons, which include: Continuation of substantial monetary and credit expansion with monetary overhang from last couple of years; Pass-through of higher oil prices; Possibility of further widening of current account deficit; Rising trend of real assets prices."
In a low per capita income country such as Pakistan where poverty is persuasive, unemployment looms large and economic growth has remained depressed for more than a decade, it would be counter-productive to dogmatically follow any single objective in formulating monetary policy, said SBP.