SBP raises discount rate to 9.5pc after IMF loan

Move aims at containing inflation, overcoming crisis of balance of payments

KARACHI - The State Bank of Pakistan raised the policy rate by 50 basis points from 9 percent to 9.5 percent with effect from September 16, 2013.
This was announced by State Bank of Pakistan Governor Yaseen Anwar while unveiling the monetary policy statement (MPS) for the next two months, at a press conference at SBP Learning Resource Centre in Karachi. The decision to raise the policy rate was taken at a meeting of the Central Board of Directors of SBP held under his chairmanship in Karachi on Friday.
According to the SBP governor, a relentless increase in fiscal borrowings and a secular decline in both domestic and foreign investments are only symptoms of structural issues. He said, “The role of monetary policy was always going to be limited in this environment; both in terms of keeping inflation low and stable and supporting private investment activity. However, in the wake of considerable deceleration in inflation over the last two years, the SBP lowered its policy rate by 500 basis points.”
Anwar said: “The impact of upward adjustments in energy prices on inflation outlook cannot be under-estimated. In addition to having a direct effect on CPI inflation, there is a high likelihood of considerable indirect effects as well. Similarly, an increase in the GST together with the removal of certain exemptions could put further pressure on inflation in the coming months. The outlook of oil prices may deteriorate as well given escalating political tensions in the Middle East.”
Anwar further said the SBP also intervened in financial markets by imposing a minimum savings deposit rate at 6 percent and containing volatility in the foreign exchange market. It also calibrated its liquidity operations in a manner that balanced financial stability considerations and medium-term inflation risks.
He added: “As a result of these actions, the weighted average lending rate has declined by 423 basis points by end-July 2013 while deposits of the banking system grew by 15.9 percent and the depreciation of exchange rate was limited to 5.1 percent in FY13.”
The SBP governor asserted a declining interest rate environment did contribute to a marginal pickup in loans to some sectors of private businesses in FY13 but most of the loans were used to fulfill the working capital requirements only. He added the real private investment expenditures have declined for the fifth consecutive year, reaching 8.7 percent of GDP in FY13.
He reiterated that higher interest rates were not the major constraining reason for the private sector credit off-take, adding two fundamental factors responsible for the lackluster increase in credit demand are persistence of energy shortages and deterioration in law and order conditions.
The SBP governor observed that increase of Rs 1,446 billion in budgetary borrowings from the banking system during FY13 was almost Rs1 trillion higher than the original target and was even higher than the total expansion in M2. “Deviation of this scale has significantly constrained effective monetary management, has disrupted financial intermediation in the economy and has led to a sharp increase in domestic debt,” he added. 
Anwar said inability to raise the tax-GDP ratio was the fundamental source of large-fiscal deficits, high borrowings and rising debt. Regarding the external sector, the SBP governor said the stress had gradually increased with every passing month of 2013 due to the shrinking net capital and financial flows and high loan repayments to the IMF. He said despite these pressures and speculations of drop in the value of Pak rupee, the foreign exchange market had largely remained stable in FY13.
Anwar said: “Clarity on the political front together with newly-initiated fiscal consolidation efforts of the government could boost offshore investors’ confidence and result in Pakistan’s return to international capital markets.”
The benchmark interest rate was raised for the first time in almost three years, shifting course after the International Monetary Fund approved a loan last week to help stabilise the nation’s struggling economy.
The IMF called for a tighter monetary policy to contain inflation and rebuild reserves in approving a $6.6 billion loan to help Pakistan avoid a balance-of-payments crisis.
“Inflation has shot up,” Tariq Hussain Khan, research head at Pearl Securities Ltd, said before the decision. “You have to act fast on inflation if you want to achieve the fiscal deficit target.”

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