Nov 30 - Dec 06, 2009

The central bank has decided to lower policy rate by 50 bps to 12.5 percent effective November 25 translating into a 0.50 percent cut in interest rate, which is expected to have a positive impact on what it is called the depressed state of the economy.

Despite a marginal relief, the reduction in interest rate should soften commodity prices especially basic food items like sugar, wheat, and rice as relented financial cost on the borrowings by sugar, rice, and flour mills has eased.

Though the inflation has fallen to the single digit i.e. 8.9 percent last month besides there is a visible sign of improvement in key macro-economic indicators, which have provided a cushion to the monitors of the financial regime to reduce interest rate at least by 150 percent, yet the central bank is playing safe in view of the volatile conditions prevailing on different fronts.

Substantiating the decision of lowering the interest rate in the monetary policy review the central bank said that striking a balance between monetary and financial stability and real economic activity has become increasingly difficult. In this perspective, SBP has decided to support the recovering real economic activity while keeping a very close watch on developments concerning the macroeconomic stability in the next two months.

The real sector is also showing signs of improvement as the large-scale manufacturing (LSM) stages a recovery after a protracted declining phase. However, a close inspection of these encouraging developments together with a pragmatic assessment of prevailing security situation in the country and fiscal uncertainties invites caution and further analysis.

Recent month-on-month inflation changes in headline and core measures continue to be volatile and on the higher side, oscillating between 0.5 and 1.7 percent in case of the former and remaining stuck at 0.8 percent in case of the later.

A reassuring fact is that the number of items in the CPI basket showing higher monthly increases relative to an historical benchmark has come down significantly. However, at the same time, the number of items displaying significant inflation persistence has also increased, which indicates the probable entrenchment of second round effects of inflationary process.

The poor administration in the supply chain of some food items is not helpful either in positively altering inflation expectations. A higher than projected fiscal deficit for FY09 has also changed some underlying assumptions for inflation outlook in FY10. In addition, the full impact of electricity and gas price adjustments, a necessary part of fiscal consolidation measures, and recent resurgence of international commodity prices, on the back of early signs of global economic recovery, remains a source of uncertainty for inflation outlook.

Apart from influencing commodity prices, the recovering global economy is expected to revive global trade and flow of liquidity across borders, which bodes well for Pakistan's exports and private financial flows. The recent strong inflow of workers' remittances and a substantially improved external current account deficit of $1.1 billion in the first four months of FY10 may allow Pakistan's economy to absorb the likely swelling of import bill induced by a nascent domestic recovery and higher international oil prices.

However, the strength and sustainability of its overall balance of payments crucially depends on resumption of foreign financial flows. Of these, portfolio inflows have picked up, direct investment has fallen, and official inflows, other than IMF, remain lower compared to projections.

Looking forward, the magnitude and timing of expected non-IMF foreign inflows remain uncertain and could increase the challenges of SBP's liquidity management and government budgetary financing.

Public sector's steady borrowing requirements have the potential to raise the Net Domestic Assets (NDA) of the banking system. Though broadly respecting the pre-announced T-bill auction targets, Ministry of Finance (MoF) has realized Rs91 billion for budgetary support against maturities of Rs37 billion in the four auctions held so far in Q2-FY10. Moreover, retirement of earlier borrowings for wheat procurement has been less than expected and to some extent neutralized by fresh borrowings for other commodities like rice, sugar, and fertilizer. Moreover, the credit availed by public sector enterprises continues to increase as well.

Although the cumulative flow of credit to private sector during the first nineteen weeks of FY10 shows retirement of Rs3 billion, it has increased significantly in the past seven weeks (Rs92 billion).

This is in consonance with the improved performance of Large Scale Manufacturing (LSM) sector in the first two months of FY10; 0.5 percent growth compared to negative 5.7 percent in the corresponding period of last year.

Given the expected improvement in supply of electricity and likely increase in global demand, private sector credit may increase further. Sustained increases in the private sector credit would depend on the extent of risk averseness by banks, scale of public sector's pre-emption of limited funding sources, and fresh injection of liquidity through a gradual build up in NFA of the banking system.

In conclusion, the overall level of risk and uncertainty in the economy has increased considerably given the present law and order situation. Consequently, the pressure on the fiscal position, especially from the financing side, has escalated and growth in the real economy is limited.



The State Bank of Pakistan has allowed rice exporters one-time facility of getting financing up to 100 percent instead of 85 percent of the value of firm export order/contract/letter of credit in order to facilitate domestic rice procurement process for exports.

The rice exporters will be required to make shipments equivalent to 100 percent instead of 117 percent against refinance availed for 270 days from the export of eligible commodities under Part-I (pre-shipment). This relaxation will be available to rice exporters only for the current 2009-10 fiscal year.