A MANIFESTO FOR MONETARY POLICY
APPROVED JOURNALIST FOR IMF MEDIA BRIEFING CENTRE
SYED ALAMDAR ALI
May 12 - 18, 2008
Despite another year of strong growth in 2007, economic activity in Pakistan slowed down late in the year and into early 2008 due to a number of political reasons. While growth remains high in Asia, led by China and India, and domestic demand is still struggling, key activity indicators in recent months suggest that momentum is slowing down. Confidence indicators also point to a slowing pace of activity. Pakistan's trade performance has also been deteriorated due to international oil price crisis and local wheat crisis. Import growth has picked up in recent months, even when excluding oil, suggesting some strength in domestic demand.
A key input into Pakistan's baseline forecast is the state of the global economy. As detailed in the IMF's April 2008 WEO and Global Financial Stability Report (GFSR), global growth is set to decline sharply this year owing to a contraction of activity in the United States and slower growth in Europe. Pakistan is not expected to delink from developments in the rest of the world. Indeed, the region's increased integration into the global economy on both trade and financial fronts suggests that Asian economies are more reliant on developments outside the region than ever before.
Country authorities in Asia have used a range of tools to combat rising inflation pressures. In China, interest rates and reserve requirements have been raised and window guidance applied in an effort to curb lending for investment, while India has used reserve requirements and benefited from a stronger rupee to contain inflation. The Philippines has used an appreciation of the peso to tighten monetary conditions (allowing for a modest lowering of policy rates), while Singapore has steepened the slope of its currency band. On the other hand, lower inflation pressures led the authorities in Indonesia and Thailand to lower rates (although inflation pressures have recently reemerged in both cases). However, the State Bank of Pakistan strives to keep headline inflation, measured by the average growth in consumer price index (CPI), at its targeted level while keeping an eye on the growth prospects of the economy through its prudent and timely use of monetary policy instruments and other related measures. Food inflation, which kept the headline inflation above the target in FY07, was anticipated to persist and magnify in FY08 as global commodities prices continued to rise. The sustained high food inflation fueled inflationary expectations and spread out to prices of general commodities through the wage-price spiral ñ generally referred to as second round impact.
The economy completed FY07 with growth at the targeted level of 7 percent, while average CPI inflation was 7.8 percent ó 1.3 percentage points higher than the target. Prevailing demand pressures, as reflected by widening fiscal and current account imbalances, and double-digit food inflation, contributed to slippages in inflation target which could have been higher but for the success of monetary policy in keeping average non-food inflation well contained as depicted by its significant decline of 2.6 percentage points.
SBP, in formulating its monetary policy for H1-FY08, anticipated and incorporated the pressures that high oil prices were to exert not only on government budget but also on overall prices in the country. Although the government has yet to pass on the increase in international prices to domestic consumers, its impact has already crept in inflationary trends as domestic price of furnace oil and various petroleum products is directly linked with international prices.
The Monetary Policy Statement issued by the State Bank of Pakistan for the first half year of the year 2008 the developments in the first half of FY08 substantially were deviated from the monetary policy framework. Most significant among these deviations is the behavior of the fiscal account, where demands for spending have far outstripped the resource envelope (defined to include current revenues and other revenue sources). Slippages from the fiscal deficit target have, and will, cause complications for monetary management during the course of the year. A gap in financing the deficit has also emerged. This was because of the delays in privatization and issuance of Global Depository Receipts (GDRs) and a Sovereign Bond, which have in past two years financed almost 41 percent of the budget deficit.
State Bank of Pakistan has to tighten its monetary policy further keeping in view the following:
(i) Developments in first half of the fiscal year and the outlook for the remaining half of the year.
(ii) Aggregate demand pressures are to remain high. Both the fiscal and the external current account deficits are likely to be higher than original projections.
(iii) Inflationary pressures are likely to build up further, with headline inflation projected to be in the range of 8.0 percent for the full year - higher than the target by 1.5 percentage points.
(iv) Though Pakistan has thus far not been significantly impacted by the global financial market turmoil led by United States subprime mortgage crisis and accompanying liquidity crunch, events are still unfolding and the second round impact on global and advanced countries" growth may bear implications as the economy is now open and fairly integrated with the international markets.
Keeping in view all the trends and prospects in the local economy SBP has decided that the emerging outlook for second half of FY08 will be assessed based on following considerations. First, monetary policy stance, since the latest policy rate increase, has begun to lose some of its steam. Expansion in M2 growth rate is above the annualized trend target for FY08 and relative to last year, MCI remained flat, and there has been a fall in the effective CRR as SBP zero rated commercial banks" financing support for exporters. Second, government has breached its quarterly target of borrowings which imply it is unlikely to retire Rs62.3 billion; the level needed to align M2 growth to the 13.7 percent target for FY08. Third, virtually all inflation indicators are showing rising trends, while the growth rate of real GDP has hovered around its target level for several years and exactly matched the target level of 7 percent for FY07.