Outlines a shift from accommodative to neutral stance

Jan 31 - Feb 06, 2005



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 country.

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 facility.

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.