As expected, the central bank on Friday kept the discount rate intact at 9.5 percent for the next two months.
The decision was taken by the Central Board of Directors of the State Bank of Pakistan (SBP) at a meeting held under the chairmanship of Governor Yaseen Anwar at the SBP Head Office.
Low financial inflows and high debt payments that currently are driving the dollar-hungry country’s balance of payments position forced the central bank to maintain the status quo.
While the external current account deficit is expected to widen further in the remaining months of FY13, the net capital and financial inflows are not likely to increase considerably. In addition, the SBP has to retire another $838 million of IMF loans during the remaining period of FY13 after making payments of $2.2 billion during the first three quarters of the current fiscal year. Due to these developments, the pressure on foreign exchange reserves is likely to remain in the coming months.
It was also observed by the Board that contrary to expectations, the year-on-year inflation has come down by 1.5 percentage points; from 8.1 percent in January 2013 to 6.6 percent in March 2013 posing divergent policy choices for the SBP. While the balance of payments position calls for caution, the declining trend in inflation indicates a possible resumption of ease in the policy rate.
In the monetary policy statement of February 2013, the SBP highlighted two main challenges for monetary policy: to manage the balance of payment position and to contain the possible increase in inflation.
Since then, SBP’s foreign exchange reserves have declined by another $2 billion; from 8.7 billion at end-January 2013 to $6.7 billion as of 5th April 2013, mainly due to debt payments. Contrary to expectations, however, year-on-year inflation has come down by 1.5 percentage points; from 8.1 percent in January 2013 to 6.6 percent in March 2013. These developments pose divergent policy choices for the SBP. While the former calls for caution, the latter indicates a possible resumption of ease in the policy rate.
The balance of payments position continues to be driven by low financial inflows and high debt payments. A cumulative net capital and financial inflow of $34 million during July–February, FY13 is insufficient to finance the external current account deficit of $700 million for the same period. While the external current account deficit is expected to widen further in the remaining months of FY13, the net capital and financial inflows are not likely to increase considerably.
It is important to emphasize that it is not the size of the external current account deficit, which is projected to be small and manageable, but the lack of adequate financial inflows that is exerting pressure on the balance of payments.
In addition, the SBP has to retire another $838 million of IMF loans during the remaining period of FY13 after making payments of $2.2 billion during the first three quarters of the current fiscal year. Thus, the pressure on foreign exchange reserves is likely to remain in the coming months. So far the SBP has played an active role in managing the conditions, but only a consistent increase in foreign exchange can ensure sustainable stability in the market.
The role of interest rate is also important in this context as it determines the return on rupee denominated assets relative to foreign currency assets. The idea is to discourage speculative demand for dollars by keeping rupee denominated assets sufficiently lucrative.
Real returns on rupee denominated assets have marginally increased due to a substantial decline in inflation. Moreover, led by a depreciation of 5.2 percent in the Nominal Effective Exchange Rate (NEER), the Real Effective Exchange Rate (REER) has also depreciated by 4.2 percent during July – February, FY13. This bodes well for the competitiveness of the external trade sector. However, real cost of borrowing has increased, which may be undesirable in the wake of declining private investment and low growth in the economy.
Despite continued energy shortages and substantial fiscal borrowings from the banking system, credit extended to private businesses has shown some nascent recovery. During July – February, FY13, loans to private businesses have increased by Rs173.3 billion as opposed to Rs56.8 billion during the same period of last year.
