INSTITUTE OF MANAGEMENT SCIENCES

MONETARY POLICY
ECONOMY OF PAKISTAN
AYESHA TARIQ

This report contains information regarding the monetary policy in Pakistan. It shows the policy
statements for the year 2o13, 2o14, 2o15 and 2o17.
Contents
INTRODUCTION.......................................................................................................................................3
HISTORY....................................................................................................................................................4
OBJECTIVES.............................................................................................................................................7
MONETARY POLICY DECISION MAKING IN PAKISTAN...................................................................7
MONETARY POLICY IN PAKISTAN.......................................................................................................8
MONETARY POLICY STATEMENT 2013................................................................................................9
Monetary policy 2014................................................................................................................................11
Monetary policy 2015................................................................................................................................12
Monetary policy 2017................................................................................................................................13
CONCLUSION.........................................................................................................................................14
REFRENCES............................................................................................................................................15

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INTRODUCTION
Monetary policy involves central banks use of instruments to influence interest rates and/or
money supply in the economy with the objective to keep overall prices and financial markets
stable. Monetary policy is essentially a stabilization or demand management policy that cannot
impact long-term growth potential of an economy. Preamble to SBP Act, 1956 envisages
monetary policy to secure monetary stability and attain fuller utilization of economys productive
resources. In SBPs view, the best way to achieve these objectives on a sustainable basis is to
keep inflation low and stable.

Low and stable inflation provides favorable conditions for sustainable growth and employment
generation over time. It reduces uncertainties about future prices of goods and services and helps
households and businesses to make economically important decisions such as consumption,
savings and investments with more confidence. This, in turn, facilitates higher growth and
creates employment opportunities over the medium term leading to overall economic well-being
in the country.

In practice, SBPs monetary policy strives to strike a balance among multiple and often
competing considerations. These include: controlling inflation, ensuring payment system and
financial stability, preserving foreign exchange reserves, and supporting private investment.

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How does Monetary Policy Work?

SBP signals its monetary policy stance through adjustments in the policy rate; that is, the SBP
Target Rate for the overnight money market repo rate. Changes in the policy rate impact demand
in the economy through several channels and with a lag. In the first place, changes in policy rate
influence the interest rates determined in the interbank market at which financial institutions lend
or borrow from each other. The market interest rates are also influenced by central bank
interventions in money and foreign exchange markets as well as by its communication.

The changes in market interest rates influence the borrowing cost for consumers and businesses
as well as the return on deposits for the savers. Generally, lower interest rates encourage people
to save less and consume/invest more, and vice versa. Changes in the policy rate also influence
the value of financial and real assets, impacting peoples wealth and thus their spending. The
adjustment in demand finally affects the general price level and thus inflation in the economy.

HISTORY
Until recently the economy seemed stable and the monetary and fiscal policies went hand in
hand with certain administrative tools to boost demand and confidence of private sector
investment, resulting in colossal economic growth.

After nuclear test (1998), several crippling sanctions had been imposed on Pakistan. This lurched
the economy from one crisis to another. But soon after 9/11 (2001), huge part of country's debt
was written off and/or rescheduled, and the supporting aid created immense fiscal space for
domestic development.

In the following year 2002, SBP pursued easy monetary policy by reducing benchmark discount
rate to 7.5% from 14% since July 2001 complemented by low cut-off yields on T-Bills and PIBs.
As a result, Pakistan's economy performed well. Tremendous improvement was seen in Pakistan,
investments amplified, increased remittances flew-in, low Government borrowing, reverse trend
in equity markets because of low interest rates, stable exchange rate, inflation down trend,
improved foreign exchange reserves, reversal of capital flight (FDI), interest rates to historic
lows which gave rise to strong surge in aggregate demand consequently Pakistan's economy

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moved on growth trajectory during FY04 and grew at 8.4%. Major contributors in growth were
Large Scale Manufacturing (LSM), and Retail Trade, which surpassed agricultural sector growth.
This was result of domestic aggregate demand facilitated by easy monetary policy,
accommodative exchange rate, deepening of consumer credit, credit to agricultural sector, access
of small borrowers to banking sector and very low export financing rates. cc. FY04 witnessed the
impacts of easy monetary policy to incite aggregate demand which contributed to rising
inflationary pressures in the economy.

SBP had to pursue accommodative monetary policy stance until January 2005, by raising cut-off
yield on benchmark 6 months T-bill early in FY04, complemented with administrative measures.
SBP did not want to disturb economic growth; she tried to maintain trade-off between the growth
and inflation. Accommodative response of central bank was due to the fact that the inflationary
pressures were caused by supply-side, driven by the excessive domestic demand, which were
supported by rising food inflation because of low performing commodity producing sector.
Along with gradual increase in cut-off yield on 6 months T-Bills, administrative steps were taken
which include allowing imports of food items from India and subsidized sale of necessary food
items through utility stores.

Central bank adopted tight monetary policy from accommodative stance during 2H-2005. In
response to the signs that economy may over heat, SBP raised its discount rate (for first time
since November 2002) in April 2005 by 150 basis points from 7.5% to 9% backed by moping up
liquidity through Open Market Operations (OMOs). As a result of these measures, both core as
well as CPI inflation started downward trend at the start of FY06 but strong demand and rising
international oil prices at that time had potential to dilute the impact of monetary stance because
inflationary expectations hardened.

Pakistan's economy continued same momentum in FY06 with real GDP growth of 6.6% and
made Pakistan third fastest growing economy in the region. Impressive growth increased hassles
because of persistent rising fiscal and current account deficits, stagnant tax base, persistent
inflation pressures and current account deficit posed serious threats to macro economic stability.

SBP tight monetary stance (since mid 2005), to curb the impacts of years of expansionary
monetary policy, started producing results and helped government to achieve its target CPI

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inflation. The SBP had to continue tight monetary policy during FY06. The discount rate
remained unchanged at 9% during IH-FY06. SBP improved its transmission of the policy rate by
moping up the excess liquidity from inter-bank market and drive the Repo rates close to discount
rate.

If you analyze the monetary policy objectives, they have been changing from maintaining
exchange rate before 2000, to growth stimuli in 2002, to contain inflation with balance growth
since FY05 till date. In 2H-05, SBP was successful in decelerating inflation along with growth in
broad money (M2) supply, which was higher than the target. Main reasons were private sector
credit growth and government spending on social and infrastructural spending and rehabilitation
of earth-quake hit areas, which were acting like filing hot air in balloon, forced SBP to raise
interest rates to contain incremental pressures. Along with this, imports and oil prices had been
increasing which put burden on current account.

State Bank Pakistan raised policy rate by 50bp to 9.5% for 2H -06. Because growth in public
expenditure was higher than the growth in revenues, which was evident from declining trend in
tax to GDP ratio, shows poor tax mobilization efforts. Growing requirements for subsidies in the
wake of soaring international oil prices, higher interest payments on domestic debt and increased
development costs were the main reasons for escalation in expenditures and government's
borrowing from banking sector. SBP kept discount rate at 9.5% but started increasing yield on T-
bills and PIBs to signal rising interest rate.

Still the key challenges remained intact like rising food inflation, soaring international
commodity prices, unanticipated reserve money growth which was pushing up aggregate demand
(due to growth in inflows, government borrowing pattern, refinancing requirements) and current
account deficit. Keeping in view all these challenges, SBP raised policy rate by 50bp to 10% in
1H-FY08, &7% on short term deposits and Zero rating CRR on long term deposits.

Monetary stances have not been productive yet as the food inflation continued hiking to the
north. Situation aggravated further, headline inflation increased to 8.01% July-Dec FY08, due to
hiking food inflation. Whilst, government borrowing from SBP was on rise which was highly
inflationary in nature, as a result 19.3% reserve money growth was evident. In response to it
SBP, in her recent monetary policy statement, raised policy rate by 50bp to 10.5% accompanied

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with increase in CCR to 8% on DTL of less than one year. SBP is continuously defending
interest rate hike by saying if SBP had not pursued tight monetary policy, food inflation would
have been higher than what it is today. It will be highly effective if government takes supply side
measures to fill gap between demand and supply.

OBJECTIVES
The preamble of the SBP Act, 1956 envisages these objectives as whereas it is necessary to
provide for the constitution of a State Bank to regulate the monetary and credit system of
Pakistan and to foster its growth in the best national interest with a view to securing monetary
stability and fuller utilization of the countrys productive resources.

SBP focuses on achieving monetary stability by controlling inflation close to its annual and
medium-term targets set by the government. At the same time, SBP also aims to ensure financial
stability, particularly the smooth functioning of the financial market and the payments system.
Consensus in literature as well as country experiences suggests that price and financial stability
facilitate the achievement of sustained economic growth in the long-run.

MONETARY POLICY DECISION MAKING IN PAKISTAN

The monetary policy decision-making primarily involves setting the policy interest rate, i.e. SBP
Policy (target) Rate. The SBPs Monetary Policy Committee reviews the monetary policy stance
after every alternative month: July, September, November, January, March, and May of a fiscal
year.

For each policy meeting of the Monetary Policy Committee, the Banks staff from the Monetary
Policy Department (MPD) prepares a detailed account of evolving developments in the domestic
economy, financial markets, and state of global economic and financial markets, which is shared
with the Monetary Policy Committee in the form of Macroeconomic Trends and Developments.
In addition, the MPD staff prepares forecasts of key macroeconomic variables such as inflation,
exports, imports, exchange rate, money demand, etc. These forecasts are combined into a

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financial programming based macroeconomic framework for preparing consistent projections of
key macroeconomic indicators of the country for current and the next fiscal year. The objective
of these forecasts and projections is to support and enhance the forward looking aspect of
monetary policy formulation. These forecasts and Macroeconomic Trends and Developments
provide background information for the discussions on monetary policy among the senior
management of the Bank.

Additionally, the Research Department staff also prepares the model-based projections using an
indigenously customized version of the Forecasting and Policy Analysis System (FPAS). FPAS is
a reduced-form New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model with
nominal rigidities. DSGE models are small to medium size economic models that combine the
major sectors of the economy into a coherent and interrelated system as a whole satisfying the
conditions for general equilibrium. The FPAS model is aimed at appraising the Monetary Policy
Committee with the short to medium-term forecast of major economic indicators - such as
headline inflation, output gap, real interest rate gap, real bilateral exchange rate gap, etc. - based
on the specified interest rate path along with some alternative policy scenarios by incorporating
the latest information. Based on its structure, the FPAS model also identifies relevant
disturbances that drive these forecasts. Normally, these projections and scenario analysis are
presented with some other independent evidence, not directly captured in the FPAS model, such
as inflation expectations and consumer confidence surveys of the economy.

In the Monetary Policy Committee meeting, SBP staff presents Banks views on the evolving
macroeconomic conditions along with projections and scenario analysis from the FPAS model to
facilitate the members of Monetary Policy Committee in building their opinion on the monetary
policy decision. After detailed discussion, the monetary policy stance is decided by the Monetary
Policy Committee through simple voting procedure.

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MONETARY POLICY IN PAKISTAN
Monetary Policy Decisions are issued every alternate month in, July, September, November,
January, March and May. They contain brief analysis of economic conditions and rationale
behind the monetary policy decision.

SBP communicates its monetary policy stance primarily through its websites and press release.
Governor SBP makes a press conference usually at the beginning and middle of fiscal years (July
and January) to present the monetary policy stance to media in addition to uploading the decision
on website and press release. In a bid to improve the communication of monetary policy and
transparency, SBP has started publishing minutes of the Monetary Policy Committee on its
website. After the monetary policy announcement, higher management of SBP makes
presentations at various forums and gives interviews to print and electronic media to further
clarify its monetary policy stance.

MONETARY POLICY STATEMENT 2013

13th November, 2013

While the challenges for macroeconomic stability in the external sector remain, the fundamentals
of the economy going forward in the backdrop of the recent policy and reform measures appear
stable. Notwithstanding rising inflation, the prospects of an economic revival inspired by
successful political transition and the resolution of energy related circular debt issue are
encouraging. To ensure the economy remains on a stable path, further structural reforms are in
progress. Although, it is too early to conclude about their impact, there are some indications of a
pickup in economic activity. The growth in LSM has accelerated with a year on year increase of
8.4 percent during Q1-FY14. Similarly, exports have also marginally picked up, growing at 1.3
percent in Q1-FY14. The deterioration in the external accounts has continued in FY14, largely
on account of weak financial inflows. The external current account had a deficit of $1.2 billion in
Q1-FY14, similar to that witnessed in the previous quarter. With imports picking up at a
relatively higher pace than exports, the widening of the trade deficit mainly explains this.
Moreover, the financial account balance had a net outflow of $68 million. Further, taking into
account substantial repayments to the IMF, SBP reserves declined by $1.3 billion during Q1-

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FY14. The SBP reserves stand at $4.2 billion as of 1st November 2013. Besides these
fundamental factors, the speculative sentiments on account of IMF end September 2013 targets
resulted in exchange rate volatility. Such sentiments are an attribute of uncertainty over foreign
exchange flows, which are expected to be reduced with sustainable improvement in the external
accounts. In this regard, the progress on reforms part of the IMF program is likely to play a
critical role. For instance, the resolution of the energy related circular debt issue has resulted in
improved supply of electricity, which is helpful for the growth in exports. Successful completion
of structural benchmarks under the IMF program will also ensure additional financial inflows
from other IFIs. In the absence of such reforms, the burden of adjustment falls disproportionately
higher on interest and exchange rates that may perpetuate speculative sentiments in the market.
Carrying out reforms, particularly those related to fiscal consolidation, are critical for the
economy. For instance, expanding the base of direct taxes and rationalizing their rates are key for
sustainable expansion of revenue collection. These are also superior to all other indirect taxes,
which are regressive in nature and require much broader documentation of the economy. While
the fiscal authorities have already progressed in this regard by increasing the GST rate, bringing
the informal sector in the tax net is an arduous task. Consequently, it is difficult to bring down
the fiscal deficit significantly. Keeping fiscal deficit, as evident from the financing side, for Q1-
FY14 within the target is plausible; however, the SBP estimates that the fiscal deficit for FY14
would be slightly higher than the budgeted 6.3 percent. The decline in the estimated FY14 fiscal
deficit, compared to 8 percent in FY13, owes much to the realization of non tax revenues such as
the CSF. The first installment of CSF ($322 million) has been realized in October 2013 and the
remaining is expected in the current and the forthcoming quarters.

Similarly, the realization of the other proceeds is also critical to maintain the deficit within this
estimated level. What is more important to consider is the fact that these are either one-off
receipts or may not be relied upon on a long term basis. A more permanent solution still lies in
the tax reforms. Similarly, rationalization of expenditures is also important. The revision in
power tariffs is expected to contribute in curtailing subsidies and thus creating fiscal space for
other expenditures. Such fiscal consolidation measures, however, have their inflationary
consequences also. Adjustments in administered prices are directly reflected in higher inflation
and raise inflationary expectations, as is evident from the current trends in CPI inflation. After
witnessing a significant decline in FY13, inflationary pressures are resurging and could be

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observed in the sharp increase in inflation during the first four months of FY14. This trend is
being contributed by both food and non-food group, however, the reversal in CPI food inflation
is relatively sharper. With the continuing of these trends CPI inflation is likely to remain at an
elevated level, between 10.5 to 11.5 percent. An increase in inflation while keeping the market
interest rates at the current level can increase the incentive for borrowings and discourage
savings in the economy. This can potentially increase demand pressure through consumption as
well as dampen investment, and thus the productive capacity of the economy. In addition, with
fragile external flows, negative real return can encourage outflow of foreign exchange increasing
the pressure on exchange rate. In light of the above, the Central Board of Directors of the State
Bank of Pakistan has decided to increase the policy rate by 50 bps to 10 percent to take effect
18th November, 2013.

Monetary policy 2014

15th November 2014

Limited impact of floods and a favorable trend in global commodity prices are the major
highlights of the post-September monetary policy decision. Indeed, CPI inflation (YoY) in
October 2014 has come down sharply to 5.8 percent. This decline is explained by: smooth food
supplies, which contained the price of perishable items; falling administered prices, which
incorporate the fall in international commodity prices, especially oil; low inflation expectations,
as witnessed by IBA-SBP consumer confidence surveys; and a significant base effect. These
developments bode well for the outlook of other macroeconomic variables in general. Given its
recent downward trend, the likelihood for inflation to end the current fiscal year on a lower
plateau is high. But, there are risks. First, downward trend over the medium to long term remains
to be seen because it is based on volatile prices of perishable items and oil. Second, other
risks identified in the previous statement, such as cut in subsidy to electricity and levying of Gas
Infrastructure Development Cess, still hold and if materialized can alter the inflation outlook on
a higher side. Third, underlying inflationary pressures on core inflation remain. The current low
oil price could salvage some of the lost growth momentum. Broadly, however, growth in Large-
scale manufacturing would remain constrained due to energy bottlenecks. Thus the main thrust to
the growth momentum would come from agriculture outcomes in the remaining months of FY15.
Barring the limited flood-related damage to some kharif crops, agriculture output is expected to

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perform better than the previous year especially now when incentive for Rabbi season crops has
been announced; such as, the recent increase of Rs100 in wheat support price. Government has
shown a significant progress in curtailing budgetary imbalances. It seems on course to achieve
further fiscal consolidation, given its current management of expenditures and borrowing pattern.
This has positive implications for the monetary management of the SBP and more importantly, in
the coming months, it would have a favorable impact on the private sector credit cycle. However,
to achieve fiscal consolidation in the long run, structural reforms to broaden the tax base remain
imperative. Low oil price along with falling inflation can improve competitiveness of Pakistani
exports. Imports, on the other hand, might take advantage of low global commodity prices and
increase further in the rest of FY15. This, at the same time, given the significant imports intensity
for exports sector in Pakistan, could add to exports competitiveness and improve its outlook
towards the end of the current fiscal year. In the mean time, current slowdown in exports is
further challenged by falling international cotton prices and stiff competition in low value-added
textile products in an environment of weak global demand. Thus, trade deficit is expected to
remain under pressure and the healthy growth in workers remittances would continue to assuage
the weaknesses in current account deficit, to some extent. It is also important to note the role of
foreign exchange inflows in domestic liquidity creation and helping the banks to extend more
credit to the private sector. This happens as government gets the space to borrow less from the
banks, thereby leaving more liquidity with the banks for credit expansion. In response to various
recent and ongoing efforts of the government, foreign exchange inflows would remain on track.
Based on these considerations, the Board of Directors, State Bank of Pakistan, has decided to
reduce the policy rate by 50 basis points to 9.5 percent with effect from 17 November 2014.

Monetary policy 2015

The average Jul-Oct FY16 inflation at 1.7 percent is lower than the 7.1 percent average inflation
in the corresponding period of last year. The decline is broad based as both food and non-food
and core inflation measures came down in this period. Going forward, with subdued outlook of
international oil price and other major commodity prices and in the absence of any shock to
supplies of food items, even though the average inflation would remain below the FY16 annual
target of 6 percent, the headline inflation is expected to reverse its declining momentum.
Moreover, market surveys indicate a marginal increase in inflation expectations for the coming

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months. Current account deficit, despite a year on year 10.6 percent contraction in exports, has
narrowed down to USD532 million in Jul-Oct FY16 from USD1.9 billion in Jul-Oct FY15. The
improvement largely owes to declining oil price that has substantially reduced the oil import
payments, healthy workers remittances, and the realization of Coalition Support Fund. At the
back of official disbursements and Eurobond inflows, surplus in capital and financial account has
supported the overall balance of payments position thus ensuring an upward trajectory in foreign
exchange reserves in Jul-Oct FY16. Going forward, continued flow of external resources would
be required to maintain the stable balance of payments position. Furthermore, realization of
investment inflows stemming from the China-Pakistan Economic Corridor would indeed
strengthen the external sector outlook over the medium to long term. Large-scale Manufacturing
(LSM), mainly supported by food and beverages, automobiles, fertilizers, and cement
production, increased to 3.9 percent in Jul-Sep 2015 compared to 2.6 percent in the same period
of last year. Further boost to this growth is expected from expansion in cotton yarn
manufacturing, strong construction activities as per planned development spending, increased
automobile production encouraged by government schemes, and improving energy supply at the
back of recent LNG imports. Credit to private sector witnessed a nominal increase in July-
October 2015; wherein fixed investments continued to expand for the fourth consecutive quarter
from Q2-FY15 to Q1-FY16. As a result of easy monetary policy, the weighted average lending
rates on fresh and outstanding loans, at 7.8 percent and 9.2 percent in September 2015, are the
lowest in 10 years. Thus, with current credit cycle now entering in uptake phase and with
improving LSM growth, borrowing on account of both the working capital and fixed investment
is likely to increase. This outlook would reflect in broad money (M2) growth going forward,
which during July 01-November 06 2015 M2 has expanded by 0.2 percent against 0.7 percent
during the same period last year. While the Net Domestic Assets declined by Rs78 billion, Net
Foreign Assets contribution in M2 growth remained substantial as it increased by Rs106 billion.
In view of the foregoing, the Central Board of Directors of SBP has decided to keep the policy
rate unchanged at 6.0 percent.

Monetary policy 2017

January 28, 2017

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The average inflation clocked in at 3.9 percent during the first half of the year, lower than the
earlier projections due to smooth supply of perishable items, stable exchange rate, and
governments absorption of the impact of higher international oil prices. The current trends
suggest that the actual inflation would be lower than the target rate of 6 percent in FY17.
Growing CPEC-related imports, decline in exports, absence of Coalition Support Fund, and
slowdown in remittances, pushed the current account deficit to USD 3.6 billion in the first half of
FY17, from USD 1.7 billion in the same period last year. This higher deficit was financed by an
increase in bilateral and multilateral funding along with pick up in investment flows. Overall
surplus in the balance of payments stands at USD 0.2 billion in the first half of the current year.
Going forward, with the aforementioned risks to the external sector, the need of financial inflows
would grow further. A sizeable net retirement of government borrowing to scheduled banks and
an increase in bank deposits helped increase private sector credit. Benefiting from the historic
low interest rates, private businesses are actively borrowing from the banking sector for
upgrading and expanding their business processes. Private sector borrowed Rs 375 billion in first
half of FY17 as compared to Rs 282.6 billion availed in the corresponding period of last year.
Loans for fixed investments increased by Rs 134.1 billion in the first half of FY17 compared
with an expansion of Rs 83.8 billion in the same period of last year. Demand for consumer
financing, especially for auto loans, also gathered pace during the first half of the year. Healthy
credit expansion, along with higher production of Kharif crops, visible improvements in energy
supply, and upbeat business sentiments signal recuperating real economic activities. Large-scale
Manufacturing grew by 3.2 percent during the first five months of the current fiscal year and
further increase is expected on account of growing infrastructure spending and recent policy
support for export oriented sectors. Based on an assessment of the above developments and after
detailed deliberations, the Monetary Policy Committee has decided to keep the policy rate
unchanged at 5.75 percent.

CONCLUSION
SBP focuses on achieving monetary stability by controlling inflation close to its annual and
medium-term targets set by the government. At the same time, SBP also aims to ensure financial
stability, particularly the smooth functioning of the financial market and the payments system.

14
Consensus in literature as well as country experiences suggests that price and financial stability
facilitate the achievement of sustained economic growth in the long-run.

REFRENCES
http://www.pakistaneconomist.com/pagesearch/Search-Engine2008/S.E145.php

http://www.sbp.org.pk/search/results.asp?
cx=002167901857236840991:v55i2sdnxfs&cof=FORID:11&q=%20history%20of%20monetary
%20policy

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