Inflation fears, liquidity constraints major factors: SBP keeps policy rate unchanged at 12.5 percent

Rising inflation fears coupled with uncertainty in liquidity outlook due to slowdown in disbursement of aid and loans has forced the State Bank of Pakistan to keep its policy rate unchanged at 12.5 percent as it struggles to sustain growth and keep inflation in check.
The Monetary Policy statement, issued by Governor SBP Syed Salim Raza on Saturday, said public sector's borrowing from the banking system continued to restrict liquidity in the system. Less than expected retirement of commodity financing and continued government borrowing through Treasury Bills to meet budgetary requirement also strained market liquidity despite a significant growth in total banking deposits (R. 265.4 billion).
To manage liquidity conditions and align money market repo rate with the easing of monetary policy stance, said Governor Raza, SBP made heavy injections (Rs 72.6 billion) to lower the daily overnight rate to 11.5 percent from an earlier average of 12.2 percent.
SBP feels that banks' appetite for lending to private sector has improved due to a slowdown in accumulation of Non-performing Loans (NPLs) since March 2009. Although, the stock of NPLs has increased to Rs 422 billion by end September 2009, the increment of Rs 18 billion and Rs 24 billion during the first quarter 2009 and first quarter 2010 was much smaller compared to an increase of Rs 65 billion during third quarter 2009. SBP hopes that as real economic activity gains momentum, the likelihood of a decline in NPLs and expansion in private sector credit increases in the coming quarters.
A worried Governor said contrary to expectations, only Rs 20 billion has been retired upto 23 January 2010. The stock for commodity financing at Rs 330 billion (of which Rs 277 billion is wheat alone) is more than double the end June averaged Rs 120 billion.
Reuters adds: The State Bank of Pakistan cut its rate by 50 basis points to 12.5 percent on November 24 after keeping it unchanged at 13 percent in September. The bank governor said average inflation for the 2009-10 (July-June) fiscal year was expected at 11 to 12 percent, down from 20.77 percent last year. Inflation was 10.52 percent year-on-year in December, after hitting its slowest pace in 22 months in October. But Raza said steps were needed to maintain the stability. "Much has been gained with respect to macroeconomic stability in a challenging economic and security environment," Raza told a news conference. "However, work needs to be done to consolidate the stability," he said.
INFLATION INDICATORS

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                                 12-MONTH       MOVING

                                  AVERAGE

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                            YOY                   FY10

                         DEC-09    DEC-09  PROJECTIONS

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CPI Headline               10.5      13.6    11.0-12.0

Food group                 10.9      13.3            -

Non-food group             10.2      13.9            -

CPI excl. HRI               9.5      12.6            -

Core Measures                                        -

NFNE                       10.7      14.6            -

20% Trimmed                10.5      15.0            -

20% Trimmed excl.HRI        9.2      14.0            -

NFNE excl. HRI              7.4      12.0            -

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