The governor, State Bank of Pakistan (SBP), Dr Shamshad Akhtar has urged the exporters to get out of the habit of depending on 'export refinancing' as it did not match the expected returns. She also rejected the demand raised by the members of business community seeking reduction in interest rates.
Speaking on "Monetary Policies of Government of Pakistan" at the Federation of Pakistan Chambers of Commerce and Industry (FPCCI), here Monday afternoon, the SBP governor said that export refinancing in Pakistan was being misused, which is not done in anywhere in the world.
Dr Shamshad Akhtar said, "The SBP being mandated to provide higher than projected refinancing for the textile sector besides its high borrowing to meet working capital requirements through EFS."
Textile exporters were allowed debt swap and new long-term borrowings which ranged around Rs 50 billion and higher than expected foreign inflows are expected to enhance the levels of net foreign assets and result in monetary expansion, the SBP governor added.
About easing monetary policy, Dr Shamshad Akhtar said in line with the evidence observed for developing countries, impact of monetary tightening on curbing inflation started to be visible after 12-18 months or so. Therefore, it is premature to ease monetary policy at the stake of sustained economic growth, he added.
Due to this measure of the SBP, CPI fell to 7.9 percent in FY06 (remaining well within the annual target of 8 percent) and CPI continued to decline to 7.7 percent in March 2007 with core inflation being still low at 5.4 percent, she said. However, CPI remains above annual target of 6.5 percent largely because of a number of factors that disrupted the impact of monetary tightening.
The SBP governor said public, businesses and market needs to develop understanding that monetary policy determines the behaviour of the price level, while inflation is precipitated by supply shocks, hoarding, official restrictions, import prices, and so on, but these influence price level in a given year..
"However, it is monetary policy that can prevent an effect on the rate of inflation over a more extended period. That is, following the initial price level shock, an appropriate adjustment of the interest rate (if necessary) can stop a potential second round of repercussions on wages and prices," said Dr Shamshad Akhtar.
The main cause of high interest rates is high inflation, through the expected-inflation premium. Conversely, the best prospect for low interest rates is a stable environment of low inflation, she added.
The SBP governor said the SBP has a current focus on anti-inflation policy, which will ensure steady growth in the long-run. Since April 2005, in response to the headline inflation reaching 11.3 percent, the central bank has been and remains in monetary tightening phase, she said, adding it has to be recognised that the inflationary pressures built up in 2005 because of the past few years of easy monetary policy.
"Though the SBP addressed this overhang by raising policy discount rate from 7 to 9 percent in April 2005, there were renewed demand pressures as fiscal and external account deficits rose in the wake of both international oil price increase as well as unforeseen spending demands triggered by the earthquake," said Dr Shamshad Akhtar.
To offset additional demand pressures, the SBP had to further raise its policy discount rate by 50 basis points in July 2006 along with 4.5 percentage point upward revision in reserve ratios, she added.
With inflation in Pakistan being relatively higher compared to its competitors and trading partners, the Relative Price Index (RPI) increased by 5.8 percent during first three quarters of FY07.
Higher domestic inflation has offset the gains emanating from nominal depreciation and the real exchange rate, measured in terms of the real effective exchange rate (REER) index, appreciated slightly by 2.5 percent during first three quarters of FY07.
About credit to the private sector, she said during July-April, net credit to private sector grew by Rs 266.4 billion or 12.6 percent against Rs 339.7 billion or 19.8 percent in the corresponding period last year.
"Despite liquidity in the system, commercial banks are not able to lend because of low demand for private sector's credit that has borrowed quite heavily in last few years. While there has been growth in working capital, the demand for fixed investment has been subdued," said Dr Shamshad Akhtar.
In the short-term, the SBP will need to maintain its monetary tightening stance and enhance its communication to influence inflation expectations, and effectively communicate that concerns about the adverse effects of higher interest rates on competitiveness and/or growth are ill-founded as the real interest rates in Pakistan are low relative to its competitors. On the occasion, FPCCI President Tanvir Ahmed Sheikh, Vice-President Zubair Tufail and other members were also present.
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