Feb 02 - 08, 2009

As anticipated, the interest rates will remain unchanged at least for next three months as the inflationary pressure does allow for any drop at the moment.

Syed Salim Raza, newly appointed Governor State Bank of Pakistan, at his first appearance before media disclosed that the SBP Central Board of Directors has decided that the central bank will issue monetary policy statement on quarterly basis. Raza said that the next monetary policy statement will be issued by the end April 2009.

When his attention was drawn by PAGE towards discriminatory attitude of the central bank towards the non-exporting industries as recently the central bank has announced one year grace on loan repayment to the export oriented industrial borrowers. Actually, this is the time to focus on domestic and indigenous resources instead of over emphasizing on exports in view of the worldwide economic slowdown and declining demand in the export market. Since the pinch of the financial crisis is being felt by all the stakeholders both export oriented or not, it is the time that the financial relief should be given to all industries and manufacturing sector across the board with a view to provide them a cushion in the harsh conditions and to avert a possible financial scam.

The governor agreed that the non-exporting industries were also equally important and the matter would be looked into in near future.

He, however, said that the extent of risks and vulnerabilities, which the economy had faced during 2008, has moderated but we would need to remain watchful of the emerging risks and challenges. He pointed out that factors such as the vulnerability of the external sector due to high oil and other commodity prices, persistence of high imports and weak prospects of foreign investment have all moderated considerably owing to improvements related to each area.

Although progress has been made with inflation, over the last four months, yet it is very stubborn in the core inflation (i.e. non-food & non-energy). The slow improvement in core inflation, while it has a structural element, is primarily owing to the fact that non fuel and non food items, such as wages and rents and fares etc. continue rising after the supply side shocks recede. This more entrenched trend is because inflationary expectations remain; for the good reason that we have had 12 months of high inflation and several preceding years during which the potential for inflation breaking out in a substantial way was being developed, he added.

He said that by the end of FY09 there will be some reduction in both the fiscal and external current account deficits in comparison to FY08. However, not only is the expected magnitude of these deficits high but also there are risks of slippages. "This signifies that the demand pressures have not completely dissipated despite a slowdown in economic activity," he said and added that the high expected average CPI inflation of 20 percent for FY09 (significantly higher than the FY09 target of 11 percent) and its persistence, reflected by core inflation measures, clearly reflect the risk on this front.

"To mitigate the implications of these risks, it is important to continue with the current monetary policy stance," he said and added, therefore, the SBP has decided to keep the policy discount rate unchanged at 15 percent. While elaborating on the more recent liquidity issues, he said that the present pressure on interest rates would have come irrespective of the discount rate as we have seen an unprecedented fall in banking liquidity post June. Between July 1 and Jan 10, deposits have shrunk by 3.4% or Rs 128 billion while total credit has grown by 11% or Rs 500bn, putting a strain of 628 on the system, or shrinking available liquidity by about 14%.

This was the simple counterpart of the CA deficit, and this level of contraction of liquidity would have raised interest rates in and of itself, regardless of where the discount rate was.

Mr. Raza said the State Bank has taken several measures to further strengthen the responsibilities of debt and monetary management including: (i)- Prior announcement of the auction calendar for Treasury Bills (T-bills) and Pakistan Investment Bonds (PIBs) and a volume based approach to determine the auction result. These are positive steps in the development of a liquid government debt market. (ii)- Ministry of Finance will henceforth be responsible for deciding the cut off yields of the primary auctions of T-bills and PIBs on the above premise.

He said the State Bank will continue to manage the operational aspect of the auctions and there will be no change in the process as far as the market is concerned and added next step in the segregation of debt and monetary management would be to work toward introducing limits on the direct government borrowings from the SBP and along with a plan to eliminate the same in a phased manner over next several years.

SBP Governor said that in order to facilitate banks in providing finance to exporters and support the industry, the State Bank has decided to further enhance banks' limits both under EFS and LTFF Schemes by Rs35 billion. As a result total limits under EFS will increase by Rs25 billion from Rs181.3 billion to Rs206.3 billion. Resultantly, cushion of Rs46.4 billion will be available with the banks over and above their current utilization of facility for meeting the requirements of the industry. Further in order to support long term investment in New Plant & Machinery, the limits under LTFF have also been enhanced by Rs10 billion from Rs9.5 billion to Rs19.5 billion, he added.

Raza said that some of the important policy measures and adjustments, which are a part of the macroeconomic stabilization package, have already been working their way through the economy and are likely to contribute towards achieving stability by the end of FY09. These include: (i)- frequent and timely adjustments in the policy interest rate that resulted in a cumulative increase of 500 bps during 2008, kept the aggregate demand and inflation expectations from spiraling out of control; (ii)- rationalization/elimination of subsidies, especially on petroleum products, that created problems for the government's budget of FY08; and (iii)- an inevitable yet needed and market driven adjustment in the exchange rate helped in putting a dent in an otherwise unsustainable growth rate of imports.

SBP Governor noted that two phenomena that had hitherto diluted the effects of the tight monetary policy have changed their direction that bodes well for macroeconomic stability. He explained that there has been a noticeable decline in the volume of government borrowings from the SBP for budgetary support. "This has been made possible because preference for subsidy took a back seat, especially after the confidence-invoking and discipline-inducing home grown stabilization package that also paved the way for successful conclusion of Stand-by Arrangement (SBA) with the IMF," he added. Secondly, after touching a record high of $147.3/bbl on 11th July 2008, oil prices have slumped to around $40/bbl as on 27th January 2009; a fall beyond national and international expectations and projections. "This drastic fall in international prices will provide a much needed respite for the trade account and coupled with tight monetary policy and prudent exchange rate management will strengthen the balance of payment position. CPI inflation is also likely to benefit from this development," he asserted.

However, Mr. Raza also asserted that despite some preliminary positive indications it would be imprudent to lower the guard at this stage. He said that the macroeconomic indicators that have recovered and the ones likely to post improvement in the next six months justify guarded optimism on close inspection. Furthermore, the full impact of demand and liquidity management measures taken by the SBP during 2008 have yet to materialize. SBP Governor said that there are indications of an improvement in the current account balance due to falling international commodity prices and strong remittances; the balance of payments position is still exposed to several risks. First, the decline in trade deficit, which is anticipated on account of a fall in imports, may prove to be less than expectations for two reasons: (i) there may be deceleration in growth of exports due to global recession and the domestic structural bottlenecks featuring intermittent power and gas supplies; (ii) the anticipated decline in oil import bill may turn out to be less than the current projections, he said.




Pakistan amongst other Asian economies especially in the South Asia Region paying a high price for the economic blunders of the Western as well as the US economies.

Actually, the big differences between the advanced economies and some of the emerging countries, particularly in Asia and the Middle East not only brought financial agonies to the Western world but for the developing economies resulted in washing out all economic achievements during last decade.

The structural problems in the West, such as the overhang of debt indicates that the persisting economic recession may not be followed by an early or strong rebound. In contrast, across many emerging countries, savings are higher and domestic imbalances are not seen, suggesting that this downturn may be more cyclical in nature than that in the West.

In parts of Asia, there is more concern about Europe than the US, with many expecting the US to rebound sooner. Moreover, many in Asia lack the confidence to believe their region can rebound before the US. There is still a commonly held view that a US recovery is required before Asia can respond. And based on events of the past few weeks and the recent loss of confidence, memories are shifting back to the Asian crisis and its aftermath, bringing a fear that it will be repeated.

It shouldn't. Asia is in a very different space. Yet Asia needs to be clear about its policy response given the fact that Korea, for instance - despite a sound economy and savings - has found itself in trouble and that Indonesia, again with solid growth, has seen its currency weaken and in the process add to problems for many corporates.

It was always the case that a US downturn would impact Asia, and this was evident both directly through slower exports and indirectly through equity markets and confidence.

Further measures are still needed - at the macro level across the globe, and in the West, even more specific ones aimed at the financial sector. These measures will naturally vary from country to country but will share many similar characteristics: more fiscal boosts, even lower interest rates, and in some Western economies, as is being seen in the US, greater use of central banks' balance sheets.

It may be recalled that in Japan in the late 1990s, it was necessary to move from traditional to so-called unconventional measures. In addition, there is still a case for further measures aimed at addressing the liquidity and capital solvency issues that have overhung the banking sector for some time.

It is still important to add liquidity, and for central banks to accept an ever wider array of collateral. There is also a case for addressing a fundamental problem where the market wants banks to have sufficient capital, but this objective is at odds with a regulatory framework that seeks higher capital ratios. Basel II and higher capital ratios are counterproductive at this stage of a cycle, dampening lending.

It may be premature to suggest we are past the worst in the financial crisis, but it does seem that way, with clear statements from the G7 that no major financial firm will be allowed to go under and many market indicators, such as interbank rates, having shifted from where they were in the stressed conditions of only a few months ago. However, whilst we may be past the worst, the financial sector, certainly in the West, is in a fragile situation.

The economists are of the view that the recovery could take years to work through the problems of various derivatives markets. There is a saying that recessions uncover what the auditors missed. And it is quite possible, or even likely, that if the recession lasts longer or the recovery is muted, some financial players may witness further problems as positions they hold and hope will recover fail to do so. The hope, though, is that whilst such problems are hard to avoid, they will not be system-wide.

For the advanced economies, 2009 will be a tough year, notwithstanding all the stimulus measures. A deep recession is already underway in the US and UK, whilst Western Europe and Japan are in a recession which, though not as deep, still looks set to be long. As a result, low interest rates, quantitative easing, and other macro measures may become the norm.