Nov 17 - 23, 2008

State Bank of Pakistan has increased the discount rate by 200 basis points which are in line with its tightening of the monetary policy to contain inflationary pressures; however the inflation continued to erode the purchasing power of the people and adding up to the cost of production of the manufacturing sector.

The government is likely to undertake more such important measures ahead of the signing of final agreement with the IMF. The Central Bank may shift payment of oil import bill to commercial banks, which might result in higher exchange rate volatility.

Dr. Shamshad Akhtar, Governor State Bank attributed the factors behind increase in the policy rate to what she called the persisting demand pressures forcing the SBP to raise the policy rate from 13 to 15 percent. It is however interesting to note that on one hand the commercial banks have refused to respond to the government's ever rising borrowings unless the SBP allows interest rate hike while on the other hand IMF was also insisting for a hike before entering into negotiations with the government for an agreement regarding rescue package.

The Central Bank however takes a plea that the increase in policy rate will not only help in aligning aggregate demand with supply but will also provide room to accommodate government's financing requirements from the commercial banks.

In addition, this will help calm the sentiments in the foreign exchange market and will also stem the second round impact of high inflation from spreading further. Appropriate monetary policy stance is only one ingredient of the macroeconomic stabilization program and as such its effectiveness depends on coordinated fiscal and external sector actions to ensure swift and sustainable stability.

Elaborating what she called the macroeconomic stabilization package chalked out by the government for the medium term, she said it is aimed to curb the growing macroeconomic imbalances and strengthen the fiscal and monetary coordination. It is also expected to facilitate official and private foreign inflows which are critical to stabilize and build the foreign exchange reserves to an adequate level. The crux of this program revolves around reducing the external current account deficit supported with appropriate exchange rate policy and bringing the fiscal deficit to sustainable levels by rationalizing expenditures and strengthening tax revenue generation. In developing this macroeconomic stabilization package, the Government and SBP have stepped up their consultations mutually and with other stakeholders over the last few months. This stabilization package, providing it is strictly adhered to by all stakeholders, will help to proactively manage supply and demand pressures which are critical to restoring economic confidence and stability.

The need for an effective macroeconomic stabilization package had heightened early in the year as the economic indicators came under stress because of the impact of global commodity price hikes combined with a persistent rise in aggregate demand pressures. Both factors have resulted in rising fiscal and external account deficits during FY08 beyond sustainable levels. These trends not only derailed hard earned economic gains of previous years, but generated inflationary pressures that are hurting public and industry at large. Challenges and risks have magnified as the unanticipated adverse macroeconomic outcome of FY08 persisted and spilled over into FY09.

Being at the forefront of demand and foreign exchange management policies, SBP has taken a range of timely measures to proactively address the challenges as and when they emerged. Since the beginning of FY08, corrective policy measures taken by SBP include:

(I) Staggered increase in the SBP policy rate to 13 percent;

(ii) Timely changes in Cash Reserve Requirement (CRR) and Statutory Liquidity Requirement (SLR) for effective liquidity management;

(iii) Encouraging aggressive resource mobilization in private sector by catalyzing banks to raise more deposits through imposition of minimum deposit rate and exempting long tenor deposits from reserve ratios- later not only allowed banks to encourage savings but address their asset-liability mismatches;

(iv) Steps to stabilize and curb excessive volatility in foreign exchange markets - though macroeconomic fundamentals rendered depreciation in currency inevitable and needed; and

(v) Assessing and monitoring closely the liquidity in the financial system and ensuring the release of desired level of liquidity through all monetary tools available at hand. Competing demand for liquidity by both public and private sector has been high given the demands of Government borrowings as well as the high credit requirements factoring in the inflationary impact.

On its part, the Government resolved to scale the exceptionally high deficit of FY08 to a more manageable level and took a host of budgetary policy measures. Specifically, subsidies on domestic petroleum products and the electricity tariffs have been eliminated over the past few months. The general sales tax (GST) rate was raised by one percentage point to 16 percent and the efforts to increase tax revenue collection have been enhanced. Also the Government has raised the wheat procurement price to stimulate production. There is a resolution to assess and solve the problem of circular debt issue. The budget for FY09 included an explicit commitment to limit the inflationary borrowings from the SBP at zero on a cumulative basis during the remaining fiscal year.

Further there has been a change in Government strategy for domestic borrowing. The steps in this regard include: (i) a cumulative increase in the interest rates for the National Savings Schemes between 200 bps to 400 bps in two phases since end June 2008, (ii) rise in the 3-month T-bill cut-off rate to 13.53 percent, which was allowed to move up the policy discount rate to attract higher financing for Government, and (iii) introducing greater flexibility to use a part of the foreign official development assistance to retire the stock of government borrowings from the SBP. It is anticipated that fiscal tightening of the desired level will be in place to ensure that monetary tightening stance is not undermined.

With the world in grip of the worst financial crisis, some sections of the society have argued for fiscal stimulus and monetary easing in Pakistan drawing parallels between the global and the Pakistan economy. SBP Governor said it is critical to recognize that the magnitude, depth, and impact of this global crisis vary across regions and countries and that the domestic macroeconomic situation differs in each country. While a number of advanced countries are facing severe liquidity crisis, which transformed into an insolvency crisis, the macroeconomic fundamentals of these countries, to start with, were in order. At the same time other large Asian countries, while being impacted by the global events, have been able to weather the storm given their strong reserve positions.

In contrast, Pakistan, hit by the global commodity price shock and given the delays in pass through of this price effect, witnessed a growth in its fiscal and external current account deficits that reached unsustainable levels and alarmingly high inflation. With stagnating tax to GDP ratio, this not only enhanced recourse to borrowings from the SBP but also resulted in a fall in foreign exchange reserves, triggering depreciation in the exchange rate. Since there are significant differences in 'diagnostics' in Pakistan and other countries it must be recognized that the policy solutions will also be different.

Despite proceeds from workers' remittances and exports of $2.3 billion and $7.1 billion respectively, the import bill of $12.9 billion has raised external current account deficit to $5.9 billion during Jul-Oct, FY09. Underlying this sharp growth in imports (35.2 percent) is the rising oil bill that reached $4.9 billion (close to $1.23 billion per month) as the international oil prices for this period averages to $123 per barrel; well above the FY08 average of $87.4 per barrel. Consequently, the share of oil bill in the total import bill has increased to 38 percent as compared with 30 percent in FY08. Non-food-non-oil imports also grew by 6.8 percent during Jul-Oct FY09, adding to the pressures.

With financial inflows slowing down ($1.1 billion only in Jul-Oct, FY09), the external current account deficit had to be financed by drawdown of SBP's foreign exchange reserves this involved depletion of reserves by $5.0 billion since the beginning of this fiscal year up to 10th Nov, 2008. The recent decline in international oil and other commodity prices bodes well for the external sector; however a sustained decline in overall import demand is critical to avoid further reserve loss after its expected build up.

She emphasized upon the need to arrest the depletion in reserves (gross reserves are now close to $6.9 billion or equivalent to 9 weeks of imports) and restore international players and market confidence to build the country's foreign exchange reserves. Weakening macroeconomic fundaments along with reserve depletion prompted depreciation in the domestic currency despite supportive foreign exchange interventions by the SBP. More specifically, sentiments in exchange markets were impacted by: (i) substantial demand for dollars emanating from increased imports and other payment requirements; (ii) drying up of financial inflows and the supply of dollars coming from export revenues and workers' remittances; (iii) the law and order situation, lowering of Pakistan's credit ratings, and low risk-adjusted rate of return on investments altogether triggered self-fulfilling expectations of erosion in the rupee value; (iv) much lower return on domestic assets as well as high inflation has led to a substitution in favour of foreign assets; and (v) central bank's limited ability to intervene in the foreign exchange market given its falling foreign exchange reserves.

Combined shock of the pressures on rupee and external liquidity had disrupted the money markets. Pressures grew as the foreign exchange outflows for payment obligations increased but the anticipated foreign financial inflows did not come through. Liquidity situation was further complicated by the seasonal Eid-related and rumor-induced deposit withdrawals by the public. It has to be recognized that the liquidity constraints emerging in Pakistan are quite different in nature and milder relative to trends prevailing in advanced countries' financial markets.

Spelling out post-July 2008, the SBP took a number of measures at appropriate times and in phases initiated by the central bank post-July 2008 to avoid other attendant risks. Cumulatively, SBP released close to Rs270 billion through lowering of reserve ratios as well as around Rs10 billion by providing 100 percent refinancing to banks under Part I of Export Finance Scheme (EFS) to meet the growing working capital financing requirements of the exporters. Furthermore, 100 percent finance will also be provided against Part II of EFS and Long-Term Financing Facility (LTFF) to promote real investment in the country. This will inject an additional amount of Rs39.5 billion in money market, making the cumulative size of liquidity comfort provided to commercial banks to Rs319.5 billion. These measures, aimed at accommodating exceptional liquidity requirements of the banking system, must not be construed as a change in the SBP's monetary policy stance. Active and calibrated liquidity management is a part of a prudent monetary management necessary to ensure effective monetary transmission mechanism which is critical to achieving financial as well as overall macroeconomic stability. Flexible application of reserve ratios and open market operations helps effective monetary management.




Al-Huda Centre for Islamic Banking & Economics organized an international workshop on Islamic Agricultural Finance in Avari Hotel, Lahore. In the workshop Islamic Financial products for agricultural sector were introduced. The key purpose for such products is to pay attention on agriculture sector by the Islamic Banks and other Islamic financial institutions. Workshop was inaugurated by Mr. Tauqeer Ahmed Fayee Central Additional Secretary for Agriculture. In his inauguration speech, he welcomes the Islamic Financial Products for Agricultural sector in Pakistan. According to Mr. Tauqeer these products were much awaited by the people related to the agricultural sector.

While addressing to the workshop, Mr. Zubair Mughal CEO of Al-Huda Centre for Islamic Banking & Economics said, it is necessary for the growing network of Islamic Banking to cater the rural areas of the country for their financial services. So the agricultural sector can avail the Islamic Financial Products for green revolution in the country. He introduced the salient features of Islamic Financial Products. He said these products can be design on the term basis of finance between the farmers and the financial institutions.

He said "BAI MURABAHA" can be used for purchase of seeds, fertilizers and pesticides. "IJARAH" can be used for purchase of Tractors, Harvesters and for agricultural equipments. "MUSHARKA" can be used for purchase of seeds, fertilizers and pesticides along with the needs for irrigation, storage and marketing of the agricultural commodities.

Islamic bonds "SUKUK" should introduce for corporate forming. "Muzara Sukuk" is based on the share in the agricultural commodity. "Musaka Sukuk" is mending for irrigation "Mogharsa Sukuk" is agricultural partnership and "Istisna Salam Sukuk". In the workshop Livestock Takaful and Crop Takaful had also been discussed.

The other speaker of the workshop were Mr. Khaliq-Uz-Zaman Head of Islamic Banking International Islamic University Islamabad, Mr. Hamad Rasool Director Finance, WAPDA, Mr. Farooq Ahmed Tung Head of Agricultural Askari Bank ltd. and some other distinguished persons.