TIGHT MONETARY POLICY REMAINS INEFFECTIVE TO CONTROL INFLATION
Feb 28 - Mar 6, 2011
Poor fiscal position and difficult monetary indicators have so far been forcing the State Bank of Pakistan (SBP) to tighten its monetary policy. The central bank has increased interest rates 150 basis points in past six months to mitigate risks to macroeconomic stability. It last raised the rate by 50 basis points to 14 percent on November 29. It however unexpectedly kept its benchmark interest rate unchanged at 14 percent, even as inflation accelerated to the fastest pace in Asia.
The governor of the State Bank, Shahid Kardar blamed the country's above-15 percent inflation rate on government borrowings and asked the government to spell out a clear and coherent strategy to limit fiscal slippages. The previous three consecutive rate rises sought to discourage government borrowing, but they proved ineffective in weaning Islamabad off State Bank funding.
Local business community had been demanding lowering of interest rate for the sake of new investments, as cost of doing business in the country was already highest in the region.
The business community criticizes the still higher interest rate, as compared to the rest of the world, making the local exporters uncompetitive in export market due to massive overheads.
'Inflationary pressures have strengthened more than anticipated during the first half of the current fiscal year 2010-11,' according to the first quarterly report of the central bank on the state of the Pakistan's economy, which was released earlier this month. The report said that the fiscal performance remains a source of concern, given the outstanding issues with expenditure management as well as revenue shortfalls.
"The implementation of fiscal reforms and elimination of subsidies in the power sector are likely to broaden the tax net and reduce distortions in the economy," the central bank's report said. "While, these reforms will induce cost-push inflationary pressures in the economy, in the short run, but these will help sustain high growth in the long run."
Though central bank mainly raised its key policy rate on concerns high inflation, yet the tight monetary policy has so far been ineffective to control inflation. The inflation, which was 12 percent in 2007-08, rose to 20.8 percent in 2008-9. It came down to 11.7 percent in 2009-10. The security situation and re-payment of loans have been the main factors contributing to the rise in inflation.
Consumer Price Index (CPI) inflation rose to 15.68 percent in December 2010, highest for the last twelve months. CPI inflation surged by 14.19 percent in January over the corresponding period of the last year. Analysts believe that fall in CPI inflation in January is temporary and it would increase when oil and electricity prices are unfrozen. The fragile government, under pressure from political parties kept the prices of oil and electricity unchanged for more than three months, despite a sudden increase in prices in the international market, reaching around $100 per barrel from 83 to 87 a month ago.
Pakistan's economy is facing serious problems of high inflation, high budget deficit, and low economic growth, according to a study recently undertaken by Pakistan Institute of Development Economics' (PIDE). Increasing tendency of government borrowing from State Bank of Pakistan (SBP) to finance the deficit and proposed implementation of Reformed General Sales Tax (RGST) are feeding the public expectations about future prices. The study indicates high inflation and high unemployment and stagnant growth during the current financial year.
Businessmen call tight monetary policy anti-industry, which has given severe blow to the ailing industry by continuously raising interest rate and fear that the high interest rate would bring the remaining industries on the verge of collapse. The country's $168 billion economy is lagging behind as emerging markets from neighboring India to China help lead the global economic rebound from the deepest postwar recession. The government forecasts the economy will expand 2.5 percent in the year through June, slower than the original target of 4.5 percent.
The task of disciplining the government's spending is now the hardest challenge for the central bank given the government's increasing needs to pay the bill to the tune of hundreds of billions of rupees for post-flood reconstruction and its inability to raise enough tax revenues and foreign assistance to support its budget. Slow economic growth and high inflation require high degree of skills to maintain balance for future of economy in the country.
International Monetary Fund (IMF) has linked the visit of a full-fledged mission with concrete steps on RGST and other revenue mobilization measures. Battered by devastating floods last year that inflicted nearly $10 billion in damage, the country's feeble economy relies heavily on IMF loan.
The IMF is the biggest contributor to the total foreign loan received by the country in the past two years. Pakistan turned to the IMF in November 2008 to avert a balance of payments crisis and has been struggling to meet the conditions of that $11 billion emergency loan. The country has so far obtained $8.7 billion from the IMF that forced the political government to take unpopular decisions like further monetary tightening and hike in power tariffs.
The imposition RGST is the part of the conditionalities of the IMF and the World Bank under the multi-billion dollar loan programmes. Islamabad will have to make hectic efforts to convince the IMF for avoiding delays into releasing the next tranche. Delay in introducing the RGST can delay disbursements under the IMF program. The critics say that RGST would have an inflationary impact and prices of consumer items would go up due to withdrawal of exemptions under the RGST regime. Imposition of RGST may increase prices of major categories of items, including food, by at least 15 percent.
After trimming the size of cabinet from 54 members to 22, Pakistani government has reportedly finalized its plan for a mini-budget in the ongoing fiscal year 2010-11, which will end on June 30. A Rs580-600 billion plan for restructuring of consolidated budget 2010-11 envisages levy of new taxes, drastic cuts in development program and an upward adjustment in power tariff with effect from March 1. With all these measures, the government expects to restrict the fiscal deficit to about 5.4 percent of GDP, while the finance minister recently forecast the fiscal deficit to be around 8 percent, higher than the central bank's prediction of between 6-6.5 percent.