SBP hikes interest rate by 2 per cent

KARACHI - The State Bank of Pakistan has raised policy discount rate further by 200bps, to 15 percent from 13 percent amid high government borrowings, persistent demand pressures, frequent hike in core inflation and widening current account deficit.

However, export refinancing facility against Part II of EFS and Long-Term Financing Facility (LTFF) would get 100 percent refinancing from the central bank that would support exports, improve liquidity into the banking system and promote real investment in the country.

Governor State Bank Dr Shamshad Akhtar announced the interim monetary policy measures for November 2008 on Wednesday at a press conference held at SBP premises in Karachi on Wednesday.

Speaking to newsmen, she said that hike in interest rate would not only help in aligning aggregate demand with supply but would also provide room to accommodate government’s financing requirements from the commercial banks. In addition, this move would help calm the sentiments in the foreign exchange market and would also stem the second round impact of high inflation from spreading further.

“Appropriate monetary policy stance was only one ingredient of the macroeconomic stabilisation programme and as such its effectiveness depends on coordinated fiscal and external sector actions to ensure swift and sustainable stability,” she said.

Considering the size of macroeconomic imbalances, Dr Akhtar said, “The SBP remains committed to achieve price stability over the medium term and thus have to launch steeper monetary tightening to tame the demand pressures and restore macroeconomic stability in FY09. Monetary tightening could reduce the external current account imbalance, reinforce fiscal tightening and discipline, arrest rising inflationary pressures, and building up the foreign exchange reserves and calming the foreign exchange market”.

She pointed out that since July 2008, the SBP took a number of measures at appropriate times and in phases to avoid other attendant risks. Cumulatively, the SBP has released close to Rs270 billion through lowering of reserve ratios as well as around Rs10 billion by providing 100 percent refinancing to banks under Part I of Export Finance Scheme (EFS) to meet the growing working capital financing requirements of the exporters. This will inject an additional amount of Rs39.5 billion in money market, making the cumulative size of liquidity comfort provided to commercial banks to Rs319.5 billion. These measures, aimed at accommodating exceptional liquidity requirements of the banking system, must not be construed as a change in the SBP’s monetary policy stance. Active and calibrated liquidity management is a part of a prudent monetary management necessary to ensure effective monetary transmission mechanism which is critical to achieving financial as well as overall macroeconomic stability. Flexible application of reserve ratios and open market operations helps effective monetary management.

Analysing economic outcome for Jul-Oct, FY09 she said firstly, continued growth in public sector spending beyond resource availability as indicated by excessive recourse to inflationary borrowing from the SBP, which reached Rs369 billion during  July 1 to November 8, 2008; of this Rs128 billion is on account of maturing T-bills, which commercial banks did not subscribe to in the auctions conducted over this period. Also Rs21.1 billion is on account of accrued profits on SBP holding of T-bills. Secondly, surge in import bill by 35.2 percent during Jul-Oct, FY09 was unsustainable given the low level of financial inflows and depleting reserves. The import bill would have had a more severe impact on the external imbalances had exports and remittances not been buoyant.

Thirdly, inflation accelerated and its expectations strengthened due to pass through of international oil prices to domestic market, increases in the electricity tariff and the general sales tax, and rising exchange rate depreciation. These developments resulted in a further rise in headline as well as core inflation (20 percent weighted trimmed measure) to 25 percent and 21.7 percent respectively in October 2008, she said.

Giving executive summary of 4-month of current financial year, she said the government resolved to scale the exceptionally high deficit of FY08 to a more manageable level and took a host of budgetary policy measures. Specifically, subsidies on domestic petroleum products and the electricity tariffs have been eliminated over the past few months. The general sales tax (GST) rate was raised by one percentage point to 16 percent and the efforts to increase tax revenue collection have been enhanced. Also the government has raised the wheat procurement price to stimulate production and there is a resolution to assess and solve the problem of circular debt issue. The budget for FY09 included an explicit commitment to limit the inflationary borrowings from the SBP at zero on a cumulative basis during the remaining fiscal year.

Further there has been a change in government strategy for domestic borrowing. The steps in this regard include: (i) a cumulative increase in the interest rates for the National Savings Schemes between 200 bps to 400 bps in two phases since end June 2008, (ii) rise in the 3-month T-bill cut-off rate to 13.53 percent, which was allowed to move up the policy discount rate, and (iii) using a part of the foreign official development assistance to retire the stock of government borrowings from the SBP. It is anticipated that fiscal tightening of the desired level will be in place to ensure that monetary tightening stance is not undermined.