State Bank of Pakistan Governor Dr Shamshad Akhtar has said that developing events on international and domestic front have enhanced the economic stress worldwide as well as Pakistan and the country's macroeconomic outcome for current fiscal year has deviated considerably from the original projections.
Addressing a press conference at the central bank head office on Thursday, she said that most countries, developed or developing, are likely to register a slowdown, and have witnessed exceptional rise in inflation, which is now emerging as the biggest challenge to the global economy.
She said that rising current account deficit, slow inflows, complications on financing of external current account deficit, higher budget deficit and over the target private sector credit pushed up the headline inflation to an alarming level.
On year-on-year (YoY) basis, it has almost doubled in just four months, moving from 8.8 percent in December 2007 to 17.2 percent in April 2008. More disturbing is the trend of food inflation, which has also doubled spiking to 25.5 percent from 12.2 percent during the same period, she added.
Although the importance of administrative supply side measures cannot be undermined in taming food inflation, the urgent need for further tightening to address their second round impact on headline inflation cannot be ignored either.
Core inflation measures, depicting persistent and mounting demand pressures, also portray worrying trends. Similarly, 20 percent trimmed measure of core inflation has peaked to 14.1 percent.
Based on current macroeconomic trends, the average headline inflation for the entire FY08 is forecast to be over 11 percent - almost double the target of 6.5 percent. These trends have undermined the past few years of monetary tightening which had significantly curbed by mid 2007, she said and added that "with oil price in the international market now hovering around US $130 per barrel, there is likely to be additional consequences for macroeconomic imbalances and inflation."
However, she said that the central banks are and will be expected to play a key role in the current global scenario to strike a balance between growth and price stability. On the balance it is being acknowledged across all economies that managing domestic demand pressures is critical in avoiding further and steeper rise of inflation; current rate of inflation has already started to impact economic growth and has induced fresh threats to economic stability.
She said that few developments stand out and reflect the unprecedented economy wide pressures and highlight the urgency of an immediate monetary policy tightening. The SBP already has announced that growing domestic vulnerabilities and risks facing Pakistan's economy given the disruptions in 2007 both on economic and political front. While, fresh pressures are visible in the country as the domestic and international economic environment and outlook has changed significantly.
She said that multidimensional global developments including the growing liquidity crunch and the rising global commodities prices as well as the rising domestic twin deficits reflect the significant aggregate demand. Together these developments are now manifesting themselves into heightened inflationary pressures, which unless curbed is expected to magnify further.
Therefore, the SBP has forced to re-examine the monetary policy framework that was based on different assumptions related to fiscal and external current account deficit as well as output growth and inflation, she added. Equally concerning is steady rise, but now a sharp spike in year-on-year indicator of food inflation. These trends have reached a proportion that are now unsustainable and without corrective actions carry risk of creating more macroeconomic complications.
Significant slippages in domestic and external deficit for FY08 and the complications of its financing mix and requirements, particularly borrowings to manage and cool-off inflation expectations and to tame the underlying dynamics, the SBP has decided to raise the policy discount rate by 150 basis points to 12 percent as of Friday, May 23rd, 2008.
The SBP has also increased Cash Reserve Requirement (CRR) for all deposits up to one year maturity by 1 percent to 9 percent, while keeping the CRR for deposits of over one year maturity unchanged at zero percent. In addition, the Statutory Liquidity Requirement (SLR) has been increased by 100bps to 19 percent of the total time and demand liabilities.
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