NEW MONETARY POLICY

Focus on containing inflation, balanced interest rates and poverty alleviation

By AMANULLAH BASHAR
Jan 30 - Feb 05, 2006

The new monetary policy sounds firmly towards containing inflation and to ensure a balanced interest rate mechanism. That is the focus of the Monetary Policy for the second half of the current financial year Dec 05-June 06, which is the first major announcement by the new Governor indicating the future direction of the central bank focusing on strict discipline in the financial regime.

Despite a slowdown noted in agriculture and industrial output during current financial year 2005-06, the central bank looked positive that the economy is on the right track and likely to achieve the targets for the current year.

The policy intended to have a tightening look at the financial regime mainly to clip the wings of soaring inflation which is major concern of society while it also advises the private sector to be more prudent and cautious in availing the credit facilities.

In fact, the central bank in an effort to check the rising inflation had made adjustment in the discount rates of the bank, which ultimately led to increase in the interest rates of the banking system. Admittedly it is done every where, yet the abnormal increase in energy price had its own impairing effects on the financial managers. The government at the highest level was however alive to the situation and had directed the financial managers to initiate measures for maintaining a balance between inflation and the financial charges. A larger segment of the economy however believes that increasing rates have telling effects on the performance of certain economic areas which had become extremely vibrant on the back of low interest rates. It is however hoped that a positive approach and a balanced monetary policy introduced by the new governor of SBP would produce the desired results.

The monetary policy also invites the attention of the government to lower reliance on short term funding and meet its borrowing requirement through issuance of long term Pakistan Investment Bonds.

The monetary policy emphasized that despite areas of relative slowdown, economic activity gives a stronger look substantiated by the broad-based expansion of bank credit to the private sector. The bank credit to the private sector, it may be noted, was registered at Rs298 billion during first half of the current financial year as compared to Rs285 billion in the same period last year.

Another important aspect of the policy, is its direction towards bringing a change in the key interest rates at an appropriate time as well as in accordance with the speed and magnitude of inflationary pressures.

The policy says that efforts would also be made for issuance of long-term instruments on the pattern of Pakistan Investment Bonds which hopefully help deepen the sovereign yield curve, and allow appropriate pricing of risk and also provide requisite benchmark for the development of capital market".

The state bank, under its policy, will ensure sufficient bank credit opportunities for all segments of the economy, including the SMEs and agriculture sector. It will encourage capacity expansion and contributing to employment growth and poverty alleviation.

The State Bank, it may be mentioned, continued to support for oil and commodities to the foreign exchange market with a net cumulative injection of $1.4 billion during first half of the financial year - this net support was estimated at 35.1 percent lower on a year-on-year (YoY) basis.

According to report, the external sector also showed considerable improvement from last year as it restricted the balance of payment, deficit of $3.8 billion during July-December 2005.

The rising inflows of foreign investment estimated around $1 billion and long-term external loans $211 million drove the capital and financial account into the positive zone of $1.8 billion.

These large inflows help contain decline of foreign reserves to only $976 million against the unprecedented import bill which swelled by 54 percent YoY to $11 billion.

THE HEADLINE INFLATION

The headline inflation declined to 8.50 percent in December 2005 after hitting a peak of 1.1 percent last year, supported by declining food prices. The continuing deceleration in headline inflation is likely to contain inflationary pressures on long term basis.

The banking spread increased further as the lending rates went higher and deposits rates slightly improved. The average lending rates moved up significantly, recording a further rise of 156 basis points to 9.77 percent since June 2005. The rise in average deposit rates remained slow as it registered only a 52 basis points rise during July-November 2005. Consequently, the banking spread rose by 104 basis points to 7.4 per cent since July 2005, the report said. It was for the first time during past many years that the inflation-adjusted average lending rate had turned positive.

The private sector credit absorption reached new highs, bank credit to the government for budgetary support rose to Rs78.3 billion as compared to Rs25.4 billion last year.

The government recourse to SBP borrowing was inevitable on the back of unforeseen spending requirements related to rescue and relief operations and rehabilitation requirements of the earthquake hit areas in Azad Kashmir and NWFP.

Reliance on borrowings from the banking system grew because non-bank system borrowings were low at Rs50 billion and marginal external financing of Rs5 billion realized in the first quarter against the full-year target of Rs121 billion.

The massive credit flow both to the private and the public sector raised the NDA of the banking system by Rs300.9 billion against the expansion of Rs241.2 billion as compared to the last year.

The total bank credit consumed by the private sector during July-December 2005 increased by 17.4 percent to Rs297.7 billion as compared to credit growth of 22.3 percent at Rs284.7 billion last year.