The State Bank of Pakistan (SBP) has further tightened its monetary policy for another six months to curb the rising inflationary trend by increasing the key discount rate by 100 basis points (bps). The central bank has also instructed federal government to retire Rs 84 billion during the current fiscal year.
State Bank of Pakistan Governor Dr Shamshad Akhtar announced monetary policy for the July-December period at a press conference at SBP head office here on Tuesday.
-- Key discount rate raised by 100 basis points to 13 percent:
-- Fiscal deficit FY08 is Rs 865 billion or 8.3 percent of GDP
-- Fiscal excesses now visible more clearly Budget deficit target of FY09 of 4.7 percent of GDP is already coming under stress
The SBP raised its key discount rate by 100bps to 13 percent effective July 30, 2008, which is the fourth consecutive increase in last one year. Earlier, the central bank raised the rate by 50 bps from 9.5 percent to 10 percent in July 2007 and some 100bps in January 2008 from 10 percent to 10.50 percent.
In May 2008 the SBP suddenly took a tight monetary stance due to rising inflation and continuous depreciation of Pak rupee against the dollar and increased the discount rate by 150 bps to 12 percent.
Addressing the press conference, Dr Shamshad Akhtar said that considering the risk relating to rising external current account and fiscal deficits and worsening inflation outlook, the central bank has decided to raise its policy rate by 100 basis points to 13 percent effective July 30, 2008.
She stressed the government to improve the supply chain and said if the supply side issues are not addressed, the ''''gap'''' could remain unchanged and the expected favourable impact on inflation will be diluted.
"These measures are necessary for ensuring price stability and long-term growth on sustainable basis and it is also expected that some demand pressures will recede in the current fiscal year," she added. She said that fiscal co-ordination with the monetary policy stance in particular commitment to scale down government borrowings from the central bank and to stop the import growth is critical to achieve the desired impact of monetary tightening.
"The banks have also refused to provide financing to federal government at present rate of 12 percent, therefore if the SBP did not raise the policy rate then it was likely that bank borrowing would also shift to the SBP," she added.
She said that considering the adverse impact of continued borrowing by the government from SBP on inflation, the SBP''''s Central Board of Directors has resolved that the government should retire Rs 21 billion in each quarter of FY09.
Dr Akhtar said in order to restore macroeconomic stability there was need for additional corrective policy actions, both at the government and central bank level. She said assuming the domestic demand continues to grow at last five-year average of 8.1 percent and the real GDP growth target of 5.5 percent for FY09 is achieved, the difference between domestic demand and supply is expected to widen further.
She pointed out that inflationary pressures in the economy are alarming as on an average, headline CPI inflation at 12.0 percent in FY08 was 5.5 percentage points above the target for the year and underlying this non-food inflation more than doubled to 13.8 percent since December 2007.
In June 2008, the headline CPI inflation (YoY) reached 30-year high of 21.5 percent, while food inflation rose to record high of 32 percent. Strong aggregate demand pressures combined with increased pass through of the persistent rise in imported oil prices contributed to high domestic inflation. On the domestic front, in addition to the demand pressures, a fall in the productive capacity of the economy is also contributing to rising inflation, she added.
"The trade-offs are not easy and global economic environment continues to be fraught with uncertainties though some trends are quite clear: global growth has slowed down, international liquidity squeeze remains and Pakistan sovereign rating prevents tapping international markets and uptrend in international commodity prices continues, in particular in oil," she observed.
Dr Akhtar underscored the need for a dynamic fiscal framework for FY09 that will incorporate necessary adjustments as economic developments evolve. She said early indications are that the budget deficit target for FY09 of 4.7 percent of GDP is already coming under stress.
Similarly, realising the estimated growth in tax revenue at 24 percent seems high given the average growth of only 12.8 percent during the last 5 years. "It must be kept in view that past few years benefited from the high and fairly robust GDP growth (7.0 percent on average); while for the coming year a growth of only 5.5 percent is being anticipated," she emphasised.
The SBP governor said the balance of payment scenario for FY09 has warranted further policy action as curtailing further import growth and raising the exports further is critical for narrowing the external current account deficit which is key to the macroeconomic sustainability.
She also stressed that additional efforts to mobilise financing to meet the external current account deficit is equally critical as the assumptions underlying balance of payment projections have changed with the rise in international oil prices and exchange rate. At the same time financing mobilisation will need to be calibrated to restore foreign exchange reserves to a more comfortable level, she added.