The State Bank of Pakistan (SBP) on Saturday announced slashing its key interest rate by 1.5 percent or 150 basis points (bps) to 12 percent for the next two months, October and November FY11/12. The regulator, however, warned that fiscal weaknesses and shrinking foreign financial inflows were haunting macroeconomic stability in the country where severe energy crisis and precarious law and order conditions were rendering domestic economic environment least conducive for productive activities.
Concerned over rapidly deteriorating global economic conditions threatening the country’s exports-led so-far-comfortable current account, the central bank also saw a gloomy prospect for the annual GDP growth target plagued masterly by the recent devastating flood in Sindh province. Given the fast declining external budgetary support, the SBP deemed it “imperative” for the politically-embattled PPP-led coalition government to broaden the country’s existing nine percent tax to GDP ratio that, the bank believed, would help the resource-constrained government scale down its reliance on bank loans.
The SBP, which was widely expected to reduce the cost of borrowing by 100 bps, took the “welcome” decision of cutting the policy rate by 1.5 percent on the back of declining inflation and government’s borrowings from the State Bank that are inflationary in nature. “There is a decline in CPI inflation and government borrowing from SBP is lower than its end-June level,” observed the SBP’s central board of directors (CBD) which met under the chairmanship of acting SBP Governor Yaseen Anwar.
The CBD said the regulator would continue to monitor developments in the fiscal sector and those pertaining to foreign financial inflows to gauge risks for macroeconomic stability in the country. The new monetary policy decision would take effect from October 10. According to CBD, the main factors contributing to the bank’s decision to cut its policy rate by 50 basis points in July (2011) continued to show positive progress.
The board, however, noted that concerns regarding weak private sector credit growth and falling real private investment expenditures remained along with a likelihood of rise in real interest rates. Further, it said that led by consistent inflow of worker remittances, the external current account position was “comfortable”, though there had been some decline in SBP’s foreign exchange reserves. At the same time, the CBD said the rapidly deteriorating global economic conditions, especially in Pakistan’s export-destination countries, did not provide much confidence either.
“In these circumstances, balancing inflation and growth considerations through monetary policy alone is difficult,” it added. About inflationary pressures in the country, the policy-setting board said the year-on-year inflation in September 2011 had come down to 10.5 percent from 13.3 percent in June (2011), though month-on-month inflation was still more than one percent on average. The SBP said that apart from seasonal factors, another source of tight liquidity conditions was a slump of $1.1 billion in the SBP’s foreign exchange reserves during the first quarter of FY11.
The main reasons, it observed, included a growth of 42 percent in oil import payments and continued decline in foreign financial flows during the first two months of FY12. “Consequently, the rupee also experienced a depreciation of 1.7 percent against the US dollar in Q1-FY12.” Thus, despite a modest external current account deficit of $189 million during July-August FY12, the assessment of overall balance of payment position requires vigilance, the SBP said.