| GEO Business | | Monetary Police for current fiscal today | Updated at: 1206 PST, Friday, July 30, 2010
 KARACHI: The central bank’s decision, regarding the key policy rate on Friday, may lean both ways as the anticipated rise in inflation would force the policymakers to tighten the monetary stance, while improvement in the economic indicators may provide room for relaxing the discount rate, analysts said on Thursday.
They, however, are unanimous that the State Bank of Pakistan (SBP) would keep the policy rate unchanged at 12.5 percent due to the prevailing economic conditions.
If the central bank kept the interest rate unchanged, it would be the fourth time in a row. The last change in the monetary policy stance was witnessed when the key rate was cut by 50 basis points to 12.5 percent in November 2009.
In its last announcement in May, the bank kept the discount rate unchanged on the basis that the economy was recovering, but lacked the necessary infrastructure and sufficient macroeconomic stability to build on the momentum.
“Stabilisation efforts over the last one-and-a-half-year have brought dividends in the shape of contraction in the external current account deficit, containment of excessive money growth and reduction in inflation,” the central bank said.
“However, worsening power crisis, which has severely hampered the economic activity and fiscal weaknesses continue to impede sustainable recovery and comprehensive macroeconomic stability. At the same time, inflation has started increasing gradually,” it said.
Experts said that the current scenario is similar to the past and the State Bank would not have room to increase or decrease the interest rate.
“The rate increase would have a negative impact on the manufacturing side and discourage the private sector to grow,” said Ahsan Mehanti, Director, Arif Habib Investments.
“On the other side, the SBP would be cautious about rising prices due to the advent of the holy month of Ramazan and threat of gradual increase in the international oil prices,” he said.
The 12-month headline inflation rose by 11.73 percent by the end of June, which was two percent higher than the actual government estimates, but lower than the SBP prediction, which forecast the inflation to be around 12-12.50 percent during the year.
“Monetary growth is suggesting that the SBP may maintain the status quo,” said Farhan Bashir Khan, research analyst at InvestCap Research.
The changes in the current account would have a direct impact on M2 growth rate (through increase in net foreign assets). The impact was visible in FY10 as the net foreign assets registered an improvement of 29.4 percent year-on-year (Y-o-Y) against the decline of 22.5 percent witnessed in FY09, he said.
“On the domestic front, the situation worsened to some extent. The government borrowing for the budgetary support increased by 19.9 percent Y-o-Y during FY10, while crowding out of the private credit became further prominent as the share of credit to the private sector diminished to 59 percent of the total net domestic assets (NDA) against 63 percent in FY09,” he said.
Higher domestic financing envisioned in the Budget FY11 should continue to divert chunk of the incremental money supply towards the government. This would rule out the possibility of a rate cut.
“However, we also cannot subscribe to a rate increase as it would severely hurt improving trend of the private credit, without achieving its critical objective of curtailing inflation,” the analyst said.
In the last country report on Pakistan released in June, the International Monetary Fund (IMF) suggested the central bank that the monetary policy should be geared at restoring the trend towards price stability.
“Inflation must not become entrenched at the current levels as it will increase poverty, impede economic recovery and harm long-term growth prospects,” the IMF said.
“The SBP should raise the policy rate promptly if inflation pressures do not abate as expected,” it said.
In the last four monetary policy decisions, the SBP tried to balance price stability with the need to support a nascent recovery. After reducing discount rate in November 2009, the central bank kept it unchanged in view of sticky core inflation, uncertain fiscal outlook with greater domestic financing needs to compensate for external financing shortfalls and expected inflationary pressure from higher energy and food price.
In the following announcement in March, it also kept the discount rate unchanged, trying to strike a balance between the imperative of reducing inflation, ensuring financial stability and supporting the economic recovery.
Historically, the policy rates started picking up due to fragile economic conditions in FY07 as the SBP increased the discount rate from 10 percent to 13 percent in July-December 2008.
The economic deterioration forced the central bank to further increase it by 200 basis points to 15 percent in an interim announcement in November 2008. It was the month, when the country approached the IMF for an emergency assistance due to adverse security developments, large exogenous price shocks, including oil and food, global financial turmoil and policy inaction during the political transition to the new government.
The GDP growth slowed down to 5.8 percent in FY08 and inflation growth hit a record high of 25 percent.
The IMF approved $7.6 billion for economic recovery, which was augmented to $11.3 billion in August 2009. |  | | | |
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