State Bank of Pakistan (SBP) has further tightened its monetary policy for another six months to curb the rising inflationary trend by increasing the discount rate by 0.5 per cent and Cash Reserve Requirement (CRR) by one per cent.
Despite the facts that the central bank has adopted a tight monetary policy since April 2005, inflation is rapidly going up and the government has failed to achieve the inflation target of 6.5 per cent during the last two years.
The monetary stance adopted has had a visible impact. Core inflation came down during FY06 and FY07, albeit slowly and with the standard lag typically observed in developing countries.
However, supply management problems affected key food items and the significant rise in global commodity prices has generated new inflationary pressures in most economies. Due to the sizeable impact of the latter on two items in particular, there has been a reversal, since May 2007, in core inflation. Trend headline inflation (Consumer Price Index) has stayed around the same level for the last two years, but this is much higher than the target of 6.5 per cent.
State Bank of Pakistan has issued Monitory Policy statement for the six months.
In the monetary policy statement, the SBP has raised its policy discount rate by 0.5 per cent to 10.5 per cent effective from February 1, 2008. This is the second increase during the current fiscal year, as earlier on July 31, 2007 the SBP had increased from 0.5 per cent to 10 per cent.
To mobilize the long-term deposits the central bank has raised the CRR by one per cent from 7 per cent to 8 per cent for deposits up to one-year maturity, while leaving term deposits of over a year zero-rated.
The bank's weighted average lending rates are expected to rise from 13 to 15 per cent on account of the 0.5 per cent rise in SBP's lending rate to banks.
SBP has to tighten its monetary policy further, recognizing the rising inflation, tremendous growth in money supply, increasing fiscal and current account deficit.
Central bank monetary policy statement showed developments in the first half of the fiscal year and the outlook for the remaining half of the year. This underscored the need for strengthening demand management, as money supply for July-January 19, of current fiscal year 2008 grew, on an annualized basis, by 19.2 per cent (relative to the 13.7 per cent target for FY08).
In addition, aggregate demand pressures are to remain high. Both the fiscal and external current account deficits are likely to be higher than original projections.
SBP said inflationary pressures are likely to build up further, with headline inflation projected to be in the range of 8 per cent for the full year – higher than the target by 1.5 percentage points. In addition to the impact of reserve money growth on core inflation and difficulties in curbing food inflation, inflationary trends are likely to be impacted adversely due to the pass through of increase in international oil prices.
Pakistan has thus far not been significantly impacted by the global financial market turmoil led by United States sub-prime mortgage crisis and accompanying liquidity crunch, the monetary statement said. However the events are still unfolding and the second round of impact on global and advanced countries' growth may bear implications, as the economy is now open and fairly integrated with the international markets.
In light of the above factors, the SBP has decided to further tighten its monetary policy for the period of Jan-July 2008.
In the monetary policy effective from February 1, 2008, the SBP has raised its policy discount rate by 50 basis points to 10.5 per cent, which will allow SBP to offload central bank borrowings, roll over the maturities of the different government securities, meet additional borrowing needs of the government from the market, and strengthen monetary policy transmission.
Concurrently, CRR is being raised by 100 basis points for deposits up to one-year maturity while leaving term deposits of over a year zero-rated. This will further incentivize the banks to mobilize long-term deposits.
Effective January 1, 2008 State Bank has already introduced a new Long-Term Financing Facility (LTFF) to facilitate export growth. Under the new scheme banks/DFIs will provide long-term financing of up to 10 years to their borrowers for import of machinery as well as purchase of locally manufactured machinery for setting up of export-oriented projects.
SBP has earmarked Rs8 billion for financing for the period between January to June 2008, which is well above the estimated demand received from the banks/DFIs for providing limits under the scheme. The SBP shall provide 70 per cent refinance to the banks/DFIs on their disbursements under the new scheme.
The borrower has the option to borrow for three different tenors, i.e., for up to 3 years, 5 years and 10 years, at financing rates of 8 per cent, 9 per cent, and 10 per cent respectively. The financing rates for end users shall remain locked in for the entire period, once the facility has been disbursed by the banks/DFIs. However, banks/DFIs have to keep the disbursements during a year in accordance with the limits sanctioned to them.
In the monetary policy SBP has also announced some measures for the affected persons of post Benazir Bhutto assassination riots across the country, as the events of December 27, 2007 resulted in losses to various private and public sector enterprises.
In order to assist such enterprises in revival of their activities, SBP is developing a relief package which includes moratorium on payment of principal and mark up in respect of the loans availed by the affected entities under Export Finance Scheme and relaxation in the shipment period under Part-I and performance requirements under Part-II.
In addition permission to banks/DFIs to provide financing for reconstruction/rebuilding of the factory premises by the affected borrowers under the recently announced Long-Term Financing Facility (LTFF); and (iii) relaxation in respect of realization of export proceeds by the affected entities on case-to-case basis.
However SBP has made it clear that above reliefs under the package shall be subject to the findings of the commission set up by the federal government pursuant to the events of December 27, 2007.
Although the SBP has taken hard decision in its monetary policy, however it would be proved in
future that the SBP monetary has been successful or not and all depends on the government’s budgetary borrowing, which is already at peak level.
Meanwhile, announcing the monetary policy, Dr Shamshad Akhtar, Governor State Bank of Pakistan, has made it clear that despite several concerns and shocks to the economy, the real GDP growth target would not be revised and it would remain 7 per cent for the fiscal year 2008.
She said presently across the world economies were facing difficulties and GDP growth rate of the world economy has declined by 0.7 per cent, although some developed countries including China's economy is consistently growing despite the challenges.
She said it was expected that despite several shocks to the economy during the last six months, GDP growth target would hover around its target of 7 per cent, however she emphasized that the risks to inflation outweighed the risks to growth in the near future.
Real lending in Pakistan is still lower compared to other regional countries, however the M2 growth is higher than the target of 13.5 per cent to 19.5 per cent, she added.
She said despite the SBP instruction to the federal government to reduce its budgetary borrowing from the central bank, borrowing is still higher and has reached Rs237 billion.
"During the current fiscal private sector borrowing statistics are still showing positive trend and is high growth over the last fiscal. At present private sector borrowing growth stood at 10.4 per cent compared to 10.2 per cent during the last fiscal,'' she said.
She said that although SBP had pay full attention to maintain and to bring down inflation, it had increased by 150 basis points. He also made it clear that if the SBP had not taken steps in the monetary policy to curb rising inflation, it could have reached double digits.
The governor elaborated that developments in the first half of FY08 substantially deviated from the monetary policy framework. Most significant among these deviations was the behaviour of fiscal account.
Slippages from the fiscal deficit target have, and will, cause complications for monetary management during the course of the year.
During the course of the year, liquidity management was challenging as the commercial banks and central bank ended up financing almost 60 per cent of the budget deficit for the July 1 - January 29, FY08 period, she added.
Notwithstanding the impact of the political uncertainty and pressures of government borrowings on the financial system, private sector credit managed to grow by 10.4 per cent during July 1 -January 19, FY08 compared to 10.2 per cent over the corresponding period of the previous year, the governor said.
