Dr Shamshad Akhtar, Governor State Bank of Pakistan (SBP) has said a tight monetary policy would continue during the next six months while the interest rates of 9.5 percent would remain unchanged.
Speaking at a press conference regarding monetary policy for the second half of fiscal year 2007 and first quarterly report on the state of Pakistan's economy for FY07 here on Thursday she said the real GDP growth target of 7 percent would be achieved. "It is expected that the GDP growth rate would cross the 7 percent mark by the end of the current fiscal year," she added.
The Governor SBP pointed out that the deposit rates have started increasing and some small banks are offering higher return rates. Public awareness is needed to look for other options to get higher deposit rates. She told that some mutual funds are offering higher deposit rates while some National Saving Schemes are also much attractive in this regard.
Monetary policy measures adopted in July 2006 augmented earlier tightening and reduced YoY core inflation (Non-Food Non-Energy - NFNE) to 5.5 percent by December 2006 from 7.4 percent a year earlier. However, the headline inflation remained stubbornly high at 8.9 percent by December 2006.
Although non-food inflation declined to 6.2 percent, acceleration in food inflation to double-digit levels offset the downtrend in headline inflation. The impact of monetary tightening is visible from an upward movement in Monetary Conditions Index (MCI) during H1-FY07.
In line with its dual objective of balancing growth and price stability, monetary policy has also supported economic growth by ensuring effective liquidity management as well as providing adequate and timely concessional credit to priority sectors.
Specifically, the liberal access of concessional Long-term Financing for Export Oriented Projects (LTF-EOP) offered by SBP and reduced rates on Export Finance Scheme (EFS) were helpful in keeping the textile industry's growth prospects intact.
Concessional financing by SBP, nevertheless, has contributed significantly to growth of reserve money during H1-FY07. The reserve money increased by 19.0 percent during H1-FY07 compared to the 8.4 percent growth recorded in the corresponding period last year; credit under EFS and LTF-EOP together explained around 54 percent of the absolute change in reserve money in H1-FY07 over H1-FY06. As a result, risks of emerging day-to-day excess liquidity seem to have increased in the money market.
Another source of reserve money expansion has been the build up in Net Foreign Assets (NFA) during H1-FY07 in contrast with a depletion during H1-FY06. Hence, a policy action to help smooth out liquidity management by scheduled banks is in order.
While keeping the average weekly cash reserve requirement same as before (3 percent for time and 7 percent for demand liabilities), SBP is increasing daily minimum requirements to 2 percent and 6 percent for time and demand liabilities (from earlier levels of 1 percent and 4 percent) respectively.
Key challenges facing the Pakistan economy remain the same as were at the beginning of FY07. In particular, (a) while inflation is likely to ease-off further it may remain above the 6.5 percent target for FY07 unless some additional administrative measures are taken to reduce food inflation; (b) international commodity prices may exert pressure on domestic inflation; (c) reserve money growth is increasing, among others because of textile sector support which is backed by SBP refinancing; (d) expansionary fiscal stance coupled with occasional upsurges in borrowings from SBP and the uncertainty created by financing mix of the deficit is posing difficulties for the conduct of monetary policy; and (e) burgeoning external imbalances also continue to pose a challenge.
SBP will continue to pursue its existing tight monetary policy stance during the remaining half of FY07. It will, however, remain vigilant of the developments in the economy and take corrective actions, if warranted.
Since the issuance of the monetary policy statement in July 2006, State Bank of Pakistan (SBP) has been closely monitoring developments in the economy and has remained vigilant about the risks and challenges identified in the statement.
These challenges were: (a) high inflation, (b) strong growth in monetary aggregates, (c) expansionary fiscal stance pushing up aggregate demand, (d) widening external account deficits, and (e) challenging international environment characterised by oil price hike and its volatility, possibility of disorderly unwinding of global imbalances, and deceleration in world economic growth.
In response to these challenges, SBP raised the cash reserve requirement (CRR) for banks, together with further increasing its policy rate by 50 bps to 9.5 percent in July 2006.
Initial evidence for FY07 suggests that SBP's monetary tightening undertaken so far has been successful in reducing excess demand from the economy, without hurting the growth momentum. In particular, while the GDP growth rate is expected to be close to the target of 7 percent for FY07 and above the FY06 level, the underlying inflationary pressures have been easing off during the first six months of FY07.
YoY core inflation (Non-Food Non-Energy - NFNE) has come down to as low as 5.5 percent in December 2006 from 7.4 percent for December 2005 and a local peak of 7.8 percent in October 2005.
However, the headline inflation has remained stubbornly high at an average 8.4 percent during H1-FY07, which is well above the annual target of 6.5 percent for FY07. In this regard, the continuing high food inflation is the key driver for pressure on the overall CPI; and has a potential to dilute the impact of monetary tightening by strengthening inflationary expectations in the economy, if not addressed timely.
While the role of administrative measures to improve supplies of essential food items has become more important, the monetary policy has to continue focusing on further containing the excessive demand pressures in the economy. Inflation outcome for FY07 is likely to be higher than the annual target for the year.
Focus on reducing domestic inflation is also required to help contain the cost of doing business in Pakistan, which is essential in improving the country's external competitive position.