KARACHI: The State Bank of Pakistan (SBP) has decided to keep the policy rate unchanged at 14 percent for another two months after incorporating the improved external position.
The decision was taken by the Central Bank's Board of Directors who met under the chairmanship of Governor Shahid Kardar, it was announced on Saturday.
"Pakistan's current economic condition reveals a mixed situation led by strong export earnings and robust growth in remittances, the external current account position has surpassed all earlier projections," the SBP said in a detailed statement while announcing the monetary policy.
However, key challenges remain in the shape of persistent inflation, weak economic growth and private investment, and a large budget deficit.
In such circumstances, SBP is endeavouring to strike a delicate balance to address the multiplicity of considerations in formulating the monetary policy stance such as containing inflation, promoting private productive economic activity, and keeping financial markets stable, it said.
The remarkable improvement in the external current account, a surplus of $748 million during July-April, FY11, has been a major positive development.
Given the turmoil in global economic conditions, especially in the export-destination and remittance-generating economies, there were expectations of an external current account deficit.
However, a spectacular rise in international cotton prices has boosted exports, which are expected to exceed $25 billion in FY11. This together with consistently rising flow of remittances helped neutralize import and other payments.
More importantly, the Central Bank said despite falling financial account inflows, $0.5 billion during July-April, FY11 compared to $3.7 billion in the corresponding period of last year, SBP's foreign exchange reserves have increased to $13.7 billion by 18th May 2011 and are expected to increase further by end-June 2011.
The SBP said, caution needs to be exercised while assessing the outlook of the overall balance of payment position.
The main reasons for this prudence include the sharp decline in international cotton prices in the last two months, likely continuation of oil prices at around $100 per barrel, and debt obligations that are due in FY12.
"Barring any unforeseen developments, these factors together with the continued suspension of IMF's Stand-By Arrangement (SBA), which has implications for other financial inflows, imply that the stellar performance of the external account may be difficult to sustain.
Therefore, maintaining the current upward trajectory of SBP's foreign exchange reserves would be a challenging task," it pointed out.
The repercussions of uncertain foreign inflows may not be limited to the external sector. Deviations in the baseline estimates could affect the net external budgetary financing as well as the monetary projections.
During 1st July to 7th May, FY11 incremental government borrowing from the banking system, including SBP, for budgetary support was Rs 614 billion registering a year-on-year growth of 28.3 percent.
Demonstrating its commitment, the government retired its borrowings from the SBP in Q3-FY11 and by end-March 2011 the stock of these borrowings (on cash basis) had come down to Rs 1155 billion.
The recent increase in these borrowings is temporary and a reflection of the government's efforts to internalize the growing quasi-fiscal expense related to the circular debt of the energy sector.
The SBP has already shifted a portion of this borrowing, Rs 61 billion, to the market through an outright Open Market Operation (OMO) and expects that government borrowing will soon converge to the end-September 2010 level, Rs 1290 billion, as committed by the government.
The average CPI inflation for FY11 is likely to remain between 14 and 14.5 percent, which is lower than SBP's earlier projections.
Another consequence of government's growing borrowing needs, both current and expected, is that the private sector credit has been squeezed out in terms of banks allocation of system's deposits.
By 7th May 2011, the year-on-year growth in private sector credit, which was mostly due to working capital needs, was 3.2 percent and that of total deposits was 15.3 percent.
The GDP growth rate of below 4 percent over the past four years appears to be highly correlated with declining real private investment expenditures and driven by consumption demand.
This coupled with severe energy shortages is negatively affecting the utilization and expansion of the economy's productive capacity.
The Central Bank said there is an urgent need to address the issue of the falling and single-digit tax to GDP ratio. The Federal Board of Revenue's (FBR) tax collection was Rs 1156 billion during July-April, FY11 and it is confident that it will realize additional revenues from the measures announced in March 2011.
Fiscal deficit for FY11 is likely to increase by approximately 0.7 percent of GDP over the revised deficit target of 5.5 percent. The final outcome will depend upon the realization of the targets of FBR revenues and provincial surpluses, it maintained.
The SBP said that for the economy to grow on sustainable basis, the debt burden to become manageable and inflation to come down to single digits, the private productive activity and investment will have to increase considerably and quickly.
This will require government borrowings from the banking system to subside to create space for private sector credit, which in turn would need satisfactory implementation of the aforementioned fiscal reforms.
The government is mindful of fiscal pressures and has expressed its resolve to address these issues, especially the containment of the fiscal deficit. The budget for FY12 is expected to reflect this commitment, it observed in the monetary policy decision.
The decision was taken by the Central Bank's Board of Directors who met under the chairmanship of Governor Shahid Kardar, it was announced on Saturday.
"Pakistan's current economic condition reveals a mixed situation led by strong export earnings and robust growth in remittances, the external current account position has surpassed all earlier projections," the SBP said in a detailed statement while announcing the monetary policy.
However, key challenges remain in the shape of persistent inflation, weak economic growth and private investment, and a large budget deficit.
In such circumstances, SBP is endeavouring to strike a delicate balance to address the multiplicity of considerations in formulating the monetary policy stance such as containing inflation, promoting private productive economic activity, and keeping financial markets stable, it said.
The remarkable improvement in the external current account, a surplus of $748 million during July-April, FY11, has been a major positive development.
Given the turmoil in global economic conditions, especially in the export-destination and remittance-generating economies, there were expectations of an external current account deficit.
However, a spectacular rise in international cotton prices has boosted exports, which are expected to exceed $25 billion in FY11. This together with consistently rising flow of remittances helped neutralize import and other payments.
More importantly, the Central Bank said despite falling financial account inflows, $0.5 billion during July-April, FY11 compared to $3.7 billion in the corresponding period of last year, SBP's foreign exchange reserves have increased to $13.7 billion by 18th May 2011 and are expected to increase further by end-June 2011.
The SBP said, caution needs to be exercised while assessing the outlook of the overall balance of payment position.
The main reasons for this prudence include the sharp decline in international cotton prices in the last two months, likely continuation of oil prices at around $100 per barrel, and debt obligations that are due in FY12.
"Barring any unforeseen developments, these factors together with the continued suspension of IMF's Stand-By Arrangement (SBA), which has implications for other financial inflows, imply that the stellar performance of the external account may be difficult to sustain.
Therefore, maintaining the current upward trajectory of SBP's foreign exchange reserves would be a challenging task," it pointed out.
The repercussions of uncertain foreign inflows may not be limited to the external sector. Deviations in the baseline estimates could affect the net external budgetary financing as well as the monetary projections.
During 1st July to 7th May, FY11 incremental government borrowing from the banking system, including SBP, for budgetary support was Rs 614 billion registering a year-on-year growth of 28.3 percent.
Demonstrating its commitment, the government retired its borrowings from the SBP in Q3-FY11 and by end-March 2011 the stock of these borrowings (on cash basis) had come down to Rs 1155 billion.
The recent increase in these borrowings is temporary and a reflection of the government's efforts to internalize the growing quasi-fiscal expense related to the circular debt of the energy sector.
The SBP has already shifted a portion of this borrowing, Rs 61 billion, to the market through an outright Open Market Operation (OMO) and expects that government borrowing will soon converge to the end-September 2010 level, Rs 1290 billion, as committed by the government.
The average CPI inflation for FY11 is likely to remain between 14 and 14.5 percent, which is lower than SBP's earlier projections.
Another consequence of government's growing borrowing needs, both current and expected, is that the private sector credit has been squeezed out in terms of banks allocation of system's deposits.
By 7th May 2011, the year-on-year growth in private sector credit, which was mostly due to working capital needs, was 3.2 percent and that of total deposits was 15.3 percent.
The GDP growth rate of below 4 percent over the past four years appears to be highly correlated with declining real private investment expenditures and driven by consumption demand.
This coupled with severe energy shortages is negatively affecting the utilization and expansion of the economy's productive capacity.
The Central Bank said there is an urgent need to address the issue of the falling and single-digit tax to GDP ratio. The Federal Board of Revenue's (FBR) tax collection was Rs 1156 billion during July-April, FY11 and it is confident that it will realize additional revenues from the measures announced in March 2011.
Fiscal deficit for FY11 is likely to increase by approximately 0.7 percent of GDP over the revised deficit target of 5.5 percent. The final outcome will depend upon the realization of the targets of FBR revenues and provincial surpluses, it maintained.
The SBP said that for the economy to grow on sustainable basis, the debt burden to become manageable and inflation to come down to single digits, the private productive activity and investment will have to increase considerably and quickly.
This will require government borrowings from the banking system to subside to create space for private sector credit, which in turn would need satisfactory implementation of the aforementioned fiscal reforms.
The government is mindful of fiscal pressures and has expressed its resolve to address these issues, especially the containment of the fiscal deficit. The budget for FY12 is expected to reflect this commitment, it observed in the monetary policy decision.