Research Analyst

Apr 21 - 27, 2008

State Bank of Pakistan has been trying to use effectively the interest rate tool in response to drastically changing economic environment of Pakistan. Her monetary policy stances have witnessed different phases from easy to tight ones over the last 5 years, resulting in economic growth at an average 7% annually.

SBP has been pursuing tight monetary stances since 2005 to keep price and growth stable. Monetary Policy 2H-08 announced by SBP is more focused to contain inflationary pressures and rectify imbalances in the economy. SBP has raised key policy rate by 150bp to 10.5% in 2H-FY08 from 9% since 2H-FY06 along with other monetary policy tools to contain inflationary pressures. Monetary policy has not achieved any concrete results yet. Inflation keeps on rising, projected in the range of 8%-9% for FY07-08. Following are the main drivers which have contributed in inflation growth consequently diluting the impact of monetary policy.


Inflation which is one of the stabilization indicators has beenrisng. March is the third month in row where CPI has touched new records owing to rising international food prices and domestic food supply disruptions. The CPI inflation in Pakistan is mostly food driven which is observable from the co-movement of the general and food inflation measures plotted in the graph. As a result, during the first half of FY08 inflationary pressures have increased further. During March CPI (General) has touched the level of 14% which is highest ever.

The State Bank of Pakistan in its recent quarterly report has also identified the rising good prices as one of the major inflation drivers which have been diluting the impact of monetary stances. External reasons of soaring food prices include increasing demand for food crops, especially corn (or maize) for ethanol and other biofuels, increased energy and freight prices and soaring edible oil prices. Domestic supply disruptions reasons include low agricultural productivity and hoardering.


Pakistan is oil importing country, which constitute major part of import bill. Currently International oil prices are hovering around $ 113/ barrel and expected to remain above $110/barrel, which has negatively affected the Pak current account. Previous government kept domestic oil prices intact till the end of its tenure for political reasons which resulted in burgeoning fiscal deficit. As new government took over, it passed the burden to end consumers in no time, in response to its adjustments prices of almost all items in CPI basket increased.


Slow growth in revenues and high government expenditures resulted in ballooning fiscal deficit, which has been expanding. In the 1H-08 tax-to-GDP ratio stood at 4.5% where as expenditure-to-GDP ratio at 9.8%, which has been highest during the last four years. Government resort to bank borrowing in order to fill revenue-expenditure gap which stood at almost Rs 360 bn during nine months of current fiscal year. The sharp rise in budgetary borrowings was the major driving force behind the high annualized M2 growth, which stood at 8% as on March 29, 2008. This was a source of concern for SBP as it had pushed inflation up and has the potential to add to the excess demand pressures in the economy.


Pakistan has been pursuing expansionary fiscal and monetary policies to create consumption led growth in an economy consequently; it created demand pull inflation in the economy. In order to contain inflation SBP pursued tight monetary stances but it has not achieved any concrete results yet owing to government had been continuing expansionary fiscal policy till today which has resulted in dilution of monetary policy stances.


Newly democratic elected government is facing dilemma which option to choose growth versus stabilization, both can not be achieved in given macro economic conditions. Government should focus on stabilization of macro economic indicators in current scenario. A comprehensive set of actions is needed to control the twin deficits and inflation. These objectives can be achieved if government improve narrow tax base and low tax-to-GDP ratio, curtail government's non-development expenditures, stop giving special treatment to few groups to save their stake, take necessary steps to stop imports of non-essential items, ensuring loans taken by borrowers from banking sector are not used for hoarding purposes last but not least diversification to energy portfolio.