Recognising the prevailing macroeconomic imbalances, the State Bank of Pakistan has announced a series of concrete adjustment measures to curb imports and drain off a portion of the excessive liquidity from the system with a view to countering the weakening of Pak rupee.
While announcing interim policy measures on Thursday Governor SBP Dr Shamshad Akhtar slapped 35 percent L/C margin on all imports except oil and selective food imports, increased the SBP policy discount rate by 150 basis points (bps) to 12 percent as of Friday May 23rd, 2008, and hiked the Statutory Liquidity Ratio (SLR) and Cash Reserve Requirement (CRR) by 100 bps to 19 and 9 percent, respectively. And, effective June 1st, 2008 it would be mandatory on all banks to pay 5 percent profit on Savings/PLS saving products.
Enhancement of 100 bps in CRR and SLR will drain off around Rs 50/55 billion leaving Rs 95 billion excess liquidity in the system. This excess liquidity is mainly concentrated in three large network banks - National, HBL and MCB Bank Limited.
Most of the smaller banks will scramble to borrow on the interbank market to meet SBP requirements for Saturday. These banks are also expected to pull investment out of Mutual Funds and redemptions are expected to put further pressure on the KSE index.
With KIBOR already up by 115 bps since February, enhancement in discount rate of 150 bps coupled with 100 bps increase in CRR & SLR - KIBOR is expected to initially jerk up 200 bps (inclusive of 115 bps already). Only after mobilising deposits, further for large deposits will KIBOR edge downward to the present level.
The PKR exchange parity with US dollar is expected to stabilise due to SBP measures. However, the forward premiums will go up by from 2.20-2.25 for six months by at least one percent to 3.20-3.25 range.
SBP wants to sterilise the $3.5 billion expected inflows to the government with reduction in the stock of T-bills held by them. The monetary data is showing a slowdown in growth of deposits ie around 7 percent while currency in circulation has gone up by 18 percent in the same period. This is half of the growth seen last year (slower due to dollarisation and investment in gold).
Total deposits are estimated at Rs 3.6 trillion while cash in circulation is 1 trillion as against last year deposit at Rs 3.2 trillion and currency circulation Rs 700 billion. Various studies have proven counter factually that monetary tightening does counter the second round effects on food driven inflation. However, the effect of monetary tightening have not given the desired result due to extraordinary borrowing by the government from SBP. Unless, the new elected government reverses this policy - the monetary tightening measures effects will get diluted.
SBP has recognised that there is inflation momentum in the pipeline and has shouldered the burden of adjustments. Whether a shaky political coalition in Islamabad is prepared to have the right magnitude and proper speed of adjustments is still up in the air - will the Budget FY09 clear the puzzle?