Moving quite in contrast to the market sentiments, the State Bank of Pakistan on Friday increased the cost of borrowing by adding 50 basis points to the current 9 percent discount rate.
The rate-hike also goes against the inducement of the IMF that had proposed monetary easing to draw foreign investment, something the dollar-hungry country needs as a permanent source of foreign exchange. The central bank instead focused more to curb the burgeoning backbreaking inflationary pressures in the country.
As the analysts described it, the unexpected and rapid increase in inflation, driven mainly by rising trend in international oil prices and devaluing rupee, has been a major factor behind the increase in the discount rate. The new policy rate would take effect from Monday, Sept 16.
The decision to raise the policy rate was taken at a meeting of the SBP’s Central Board of Directors held at SBP under the chairmanship of SBP Governor Yaseen Anwar. “Fundamental issues for sluggish long-term economic growth in Pakistan such as weak economic management and low productivity had largely remained unaddressed,” said Anwar while unveiling the Monetary Policy Statement (MPS) for the next two months during a press conference at the SBP. He said the “economy has experienced bouts of growth and stable inflation but a sustainable performance has remained largely elusive”.
According to the SBP governor, a relentless increase in fiscal borrowings and a secular decline in both domestic and foreign investments are only symptoms of structural issues. “The role of monetary policy was always going to be limited in this environment; both in terms of keeping inflation low and stable and supporting private investment activity. However, in the wake of considerable deceleration in inflation over the last two years, the SBP did lower its policy rate by 500 basis points.”
Anwar said the SBP also intervened in financial markets by imposing a minimum savings deposit rate at 6 percent and containing volatility in the foreign exchange market. It also calibrated its liquidity operations in a manner that balanced financial stability considerations and medium-term inflation risks. As a result of these actions, he said the weighted average lending rate declined by 423 basis points by end-July 2013 while deposits of the banking system grew by 15.9 percent and the depreciation of exchange rate was limited to 5.1 percent in FY13.
He said the real private investment expenditures have declined for the fifth consecutive year, reaching 8.7 as percent of GDP in FY13. He said higher interest rates were not the major constraining reason for the private sector credit off-take, adding that two “fundamental factors responsible for the lackluster increase in credit demand are: persistence of energy shortages and deterioration in law and order conditions”. He said the increase of Rs1.446 trillion in budgetary borrowings from the banking system during FY13 was almost Rs 1 trillion higher than the original target and was even higher than the total expansion in M2. “Deviation of this scale has significantly constrained effective monetary management, disrupted financial intermediation in the economy, and has led to a sharp increase in domestic debt,” he said.
Anwar said that the inability to raise the tax-to-GDP ratio was the fundamental source of large fiscal deficits, high borrowings, and rising debt. He further said that with swift settlement of the outstanding stock of energy sector circular debt, reduction in electricity tariff related subsidies, and introduction of some taxation measures the new government has shown intentions to address deeper issues afflicting the fiscal accounts. Regarding the external sector, the SBP governor said the stress has gradually increased with every passing month of 2013 due to shrinking net capital and financial flows and high loan repayments to the IMF. Anwar said despite these pressures and speculations of a drop in the value of the Pak rupee the foreign exchange market had largely remained stable in FY13. He said the likelihood of receiving higher financial flows has increased given that a new IMF program has been approved for Pakistan in September 2013. This would ease pressure in the foreign exchange market. Anwar said the impact of upward adjustments in energy prices on inflation outlook cannot be under-estimated. In addition to having a direct effect on CPI inflation, there is a high likelihood of considerable indirect effects as well, he added.
SBP raises rate for first time after IMF loan
