The State Bank of Pakistan (SBP) recently released
its Monetary Policy statement for the second half of current financial
year. There was a mixed reaction to the policy. While some analysts
termed it tightening of belts, others found no surprises. However, it
clearly outlines a shift from accommodative to neutral stance. It also
appears that the central bank is serious about containing the inflation
but at the same time does not wish to disrupt the pace of investment in
The SBP in the policy clearly indicates that the
change in the stance is primarily aimed at arresting the rising
inflation. However, some analysts say that the rise in inflation rate is
not purely a domestic phenomenon. They hold a number of external factors
responsible for cost pushed inflation in the country, the worst being
higher international oil prices. Though, the GoP has resisted increasing
POL prices for over six months, the inevitable happened.
According to an analyst, the local POL prices hardly
has any relevance with the international oil prices. To support their
point they say that the two global benchmarks, US light crude and Brent
North Sea crude prices are totally irrelevant for Pakistan. Secondly,
Pakistan gets crude at a price, which is even lower than OPEC basket.
And above all bulk of the retail prices of POL products comprise of
government taxes. Therefore, the retail prices should have been half of
the prevailing prices.
As regards interest rates, it is also being said that
Pakistan is also following a global trend rather formulating its own
strategy. Over the last two months, most of the global central banks
have adopted a more stringent monetary policy. The phenomenon has been a
result of rising global inflation, fueled by the escalating average
international oil prices. Countries like the USA, China and many other
developed countries are following the similar strategy and Pakistan is
no exception to this global phenomenon.
While the BP is very clear that it will not allow
interest rate adjustment to stifle economic growth, there are clear
indications that rates will be raised until inflationary pressure is
significantly eased off. The biggest display of this stance is rising
yield on Treasury Bills. The central bank has not only been mopping up
the overflowing liquidity but also raising the average yields.
Just a few hours before the official release of the
monetary policy, the SBP held auction of 3-month and 12-month T-Bills.
As against a target of Rs 60 billion, the central bank mopped up Rs
75.76 billion. It also raised the 3-month cut off yield by 38 basis
points to 4.33%. Similarly yield on 12-month bills was raised by 48
basis points to 4.99%. This clearly shows that the central bank will
continue to raise the yield and may be in a steeper manner.
A question arises will the increase in interest rates
help in containing inflation? The growing perception is that any
increase in interest rates cannot help in containing inflation. There is
so much liquidity or over supply of currency in the country that mopping
up of even large sums hardly make any impact. As along as the economy is
not fully documented it is almost impossible to contain inflation by
increasing interest rates. On top of this banks are sitting on tonnes of
money. Though, there has been an increase in advances, banks are unable
to fully deploy the available deposits.
Commercial banks and other financial institutions at
one time were investing heavily in equities. However, the SBP regulation
demanded from them to reduce such exposure. Since this option is no
longer available and other opportunities are limited they have ventured
into commodity financing. This became the real reason for hike in
inflation rate. Easy availability of funds has led to hoarding of food
items as well as fertilizers. Availability of finances at softer terms
has also raised prices of real estate and in turn rentals.
Apparently, the central bank is caught in a difficult
situation. Any attempt to raise short-term lending rates also pushes up
long-term rates, which in turn discourages long-term investment. To
facilitate investment and encourage exports, the central bank has
abstained from raising interest rates on financing of locally
manufactured machinery and export refinance. However, it is expected to
yield only limited benefits because bulk of the investment is being made
in the imported machinery and scope of export refinance is still very
limited. The exporters who need the funds most often cannot avail of the
Therefore, it is recommended that the GoP offer some
extra incentives for investment and exports. The GoP wishes to double
country's export over the next five years. Creation of value adding
facilities and higher exports can also help in improving the standard of
locally manufactured as well as curb smuggling. More exports will also
lead to better economies of scale.