Eight out of 10 analysts polled by Reuters expect the central bank to increase its key policy rate by at least 50 basis points to 14.5 percent to combat double-digit inflation, which is becoming a potentially explosive problem for the government.
The consumer price index in December rose 15.46 percent from a year earlier, but fell 0.51 percent from November and is likely to fall further due to the base effect. However, the main threat to inflation is continued government borrowing from the State Bank of Pakistan (SBP).
"We believe that despite the base effect and price reversal benefit for inflation, it will be difficult for the SBP to keep the rate constant, as future government borrowing requirements are likely to increase further," said Khalid Iqbal Siddiqui, director at Invest and Finance Securities Ltd. The government borrowed an estimated Rs 119.6 billion ($1.39 billion) from the central bank from July 1 to January 15, compared with a net retirement of 19.4 billion rupees in the same period last year. This increases the money supply, which fuels inflation.
The government's borrowing from commercial banks has also increased substantially to Rs 217.5 billion ($2.53 billion) from July 1 to January 15, compared with Rs 170.9 billion ($1.99 billion) last year. The central bank forecasts inflation to average between 13.5 percent and 14.5 percent for fiscal year 2010/11, while the International Monetary Fund forecasts it to average 14 percent.
With international commodity prices on the rise, a failure to implement tax reforms and no foreign funding - including the sixth tranche from the International Monetary Fund - scheduled for the next few months, the government will likely need to borrow more from the central bank and commercial banks. This leads most analysts to believe that the central bank is likely to increase the key policy rate by 50 basis points, which would mark the fourth straight increase.
The minority view is that the State Bank of Pakistan will leave rates unchanged and wait because the current account has a surplus of $26 million from the six months ending December 31. They say this will boost the rupee and offset inflation.
According to analysts, the 2010/11 budget deficit is most likely to end at more than 7 percent of GDP, compared with a target of 4.5 percent agreed with the IMF. It will be aggravated by a rise in international oil prices and a government reversal of a hike in local fuel prices this month because of political pressure.