State Bank reduces policy rate by 50 bps to 13.5%

Karachi: State Bank of Pakistan SBP Saturday decided to reduce its policy rate by 50 basis points to 13.5 percent with effect from August 01, 2011.

This was announced by Yaseen Anwar, Acting Governor SBP while unveiling Monetary Policy Statement in press conference at SBP, Karachi. The key parameter in this assessment is the outlook of inflation that indicates that average inflation in FY12 is expected to remain in line with announced target, he said, adding that no adjustment in the interest rate would have entailed further tightening of monetary policy in real terms, which is not warranted given the decline in private investment.

He said despite fiscal slippages, the government has adhered to restricting the stock of its borrowings from SBP to Rs 1155 billion (on cash basis). “In fact, the government retired these borrowings compared to both end-June 2010 level as well as mutually agreed limit of end-September 2010 level,” he added.

He said government also expressed its commitment to continue with a stance of zero borrowings from SBP in yearly flow terms in FY12, which bodes well for anchoring inflation expectations. He observed that developments related to expected financial inflows and pattern of government borrowings from scheduled banks will need to be monitored closely to assess potential risks for macroeconomic stability.

SBP Acting Governor said a relative decline in average CPI inflation compared to earlier projections and a gradual build-up of foreign exchange reserves provide a modicum of macroeconomic stability as the economy begins a new fiscal year. He noted that expectations of inflation are fairly entrenched in the economy. “Thus, a meaningful reduction in inflation would require consistent and credible implementation of monetary and fiscal policies,” he stressed.

He said acknowledging the persistence of inflation, government has announced an inflation target of 12 percent for FY12. The government has also provided in Medium Term Budgetary Framework MTBF a desired path of inflation of 9.5 percent and 8 percent for subsequent two years. Conditional on factors such as adjustments in administered prices of electricity and oil and a projected broad money (M2) growth of 15 to 16 percent, SBP’s forecast of average inflation ranges between 11 and 12 percent during FY12, he added.

“The underlying reasons of growing government borrowings are structural and not specific to FY11 though it must be acknowledged that FY11 was a difficult year given floods and other pressing spending needs. The consolidated fiscal data has not been released, however, provisional estimates from financing side indicate that fiscal deficit in FY11 may have reached close to Rs 1127 billion or 6.2 percent of GDP. Excluding one-off payment of Rs120 billion to partially settle circular debt in energy sector, fiscal deficit in FY11 comes down to 5.6 percent of GDP,” he stated.

Anwar underscored need to accelerate implementation of fiscal reforms currently being considered by the government. A path of fiscal deficit in next three fiscal years has been provided in MTBF, which shows budget deficit target of 4 percent for FY12. “Moreover, the government is planning to reduce revenue deficit to zero in FY12 with a projected surplus in following two years. This assumes an ambitious increase in tax collection by Federal Board of Revenue FBR,” he said, adding that an effective implementation of fiscal reforms, especially those related to broadening of tax base, and better coordination with the provinces are urgently required to implement this plan.

He said unlike fiscal accounts, the position of external current account improved considerably in FY11 and contrary to earlier projections, a surplus of $542 million has been realized. “A significant and unexpected growth of 29.4 percent in exports and a robust growth in workers’ remittances, which now stand at $11.2 billion, are primary factors responsible for this improvement. Fragile global economic conditions and dominance of price effect in both exports and imports, which was more pronounced in H2-FY11, has increased exposure of the economy to movements in international commodity prices.”

SBP Acting Governor said external current account is expected to show modest deficit of 0.8 percent of GDP in FY12. “Given an increase in debt obligations and continued suspension of IMF’s Stand-By Arrangement (SBA) financing even a small external current account deficit could pose challenges in terms of maintaining an upward trajectory of SBP’s foreign exchange reserves.”

He said main risk in external accounts emanates from declining capital and financial flows, which have dropped to $1.8 billion in FY11 from $5.3 billion in FY10. The perceived high country risk, relative to other emerging market economies, is main factor underlying reluctance of private foreign investors to invest in the country. The delays in implementation of economic reforms, on the other hand, resulted in shortfalls in estimated foreign loans. Nonetheless, by end-June 2011, SBP’s liquid foreign exchange reserves have increased to $14.8 billion from $13.0 billion at end-June 2010.

He said gross fixed capital formation by private sector contracted by 3.1 percent, leading to a decline in total gross investment to 13.4 percent of GDP; lowest level since FY74. He said due to strong growth in real consumption expenditures, aggregate domestic demand grew by 5.9 percent. At the same time, national savings have increased to 13.8 percent of GDP, mainly due to net factor income from abroad. Consequently, gap between national savings and investment as a percent of GDP has turned marginally positive, he noted. “Against this backdrop, SBP has decided to reduce the policy rate by 50 basis points to 13.5 percent effective 1st August 2011.”

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