MONETARY POLICY DECISION

27th March 2010 Building on initial gains in macroeconomic stability the economy is looking to further its traction for sustainable recovery. Inflationary pressures have dampened but continue to persist, mainly due to alignment of energy sector prices with market factors. Large Scale Manufacturing (LSM) has consistently grown since October 2009 after contraction for almost 20 months but remains fragile. Reduction in the external current account deficit has allowed SBP to rebuild foreign exchange reserves, despite shortfalls in external financial flows. However, uncertainty has increased in some areas, particularly the fiscal sector, with implications for the rest of the economy, including monetary policy. Although CPI inflation (YoY) has come down to 13.0 percent in February 2010, it is high and exhibits persistence. After a low of 8.9 percent in October 2009, inflation slipped back largely due to increases in electricity tariffs, adjustments in the prices of domestic petroleum products, and administered prices of commodities like wheat. To which extent these factors will influence other prices in the economy and expectations of inflation in the coming months remain difficult to assess. Nonetheless, SBP expects the average CPI inflation for FY10 to remain close to 12 percent. Despite presence of high inflation, crippling electricity shortages, and challenging security conditions, domestic economic activity has picked up in recent months. A cumulative growth of 2.4 percent during the first seven months of FY10 in the Large Scale Manufacturing (LSM) is encouraging. Sustainability of this trend in LSM and overall economic growth would depend on improvements in the availability of electricity and security situation. In addition, this would need supportive growth in private sector credit, which in turn depends on a reduction in the scale of government and public sectors reliance on bank borrowings. The balance of payments position has improved considerably. The external current account deficit has come down to $2.6 billion during July February, FY10 compared to $8 billion in the same period last year. This has allowed SBP to accumulate foreign exchange reserves, $11.1 billion as on 26th March 2010, and has facilitated stability in the foreign exchange market. However, other developments in the external sector, such as Foreign Direct Investments (FDI) and workers remittances, need to be monitored closely, especially when prospects of foreign official flows remain unclear. The key source of uncertainty, however, lies in the weak fiscal position. Burdened by significant security related expenditures and shortfalls in revenues, keeping
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the fiscal deficit for FY10 within target would be challenging. Partial phasing out of subsidies and reduction in development expenditures have helped in containing expenditures but has lead to surge in domestic prices and is hurting crucial public sector investment. Similarly, increased Petroleum Development Levy (PDL) receipts, due to higher oil imports, have cushioned the lower tax revenues to some extent but have contributed towards inertia in domestic inflation. During the remaining months of FY10, uncertainty regarding non-tax revenues on account of foreign reimbursements and extent of remaining power sector subsidies adds to fiscal complications. The financing mix of the fiscal deficit also seems uncertain. The external financing for budget, especially the part pledged by the Friends of Democratic Pakistan (FoDP), has mostly been elusive. Of the Rs110 billion net external budget financing received during H1-FY10, Rs93 billion were provided by the IMF. With an understanding that this part of IMF money, provided in lieu of FoDP flows, is for short term, the importance of the timing of external budgetary flows cannot be overemphasized. Not surprisingly, therefore, government borrowing from the SBP has been substantial in Q3FY10. According to provisional figures the outstanding stock of government borrowing from SBP (on cash basis), as on 25th March 2010, stands at Rs1240 billion, which is Rs110 billion higher than the quarterly ceiling limit. With less than expected retirement of credit availed by the government for commodity operations and commencement of the 2010 wheat procurement season, pressure will build on the banking system resources. Continued borrowings by the Public Sector Enterprises (PSEs), partly because of the lingering energy sector circular debt, are also straining systemic liquidity. Further, the high infection ratio of credit to Small and Medium Enterprises (SMEs) at 22 percent and Agriculture at 17 percent may lead banks to show reluctance to extend credit to the private sector even when the pace of growth of incremental Non-performing Loans (NPLs) has slowed considerably in the last quarter of 2009. In this environment, with resources tied up in both commodity and circular debt and risk averse behaviour, banks will tend to negotiate higher rates on risk-free or government guaranteed debt. For instance, the first issuance of the Term Finance Certificate (TFC) in March 2009 was priced at KIBOR plus 1.75 percent, while the second issuance in September 2009 was at KIBOR plus 2 percent. Similarly, the rates for financing commodity operations were around KIBOR plus 2.5 to 2.75 percent. This reflects that banks are building in the cost of ongoing rollover, instead of repayment, of outstanding credit. Thus, the attractively priced government borrowing may lead to stagnation in private sector credit growth.
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Government will have to revisit its commodity intervention strategy, sooner than later, so that commodity operation requirements may go back to normal levels. Similarly, a complete resolution of the circular debt would be essential. Apart from releasing banking system resources and easing pressure on market rates, it will alleviate some constraints impeding production of electricity in the country thus paving way for sustainable economic recovery. Given the uncertainties pertaining to the fiscal and quasi-fiscal sectors, present stance of monetary policy is striking a difficult balance between reducing inflation, ensuring financial stability, and supporting economic recovery. An upward adjustment in SBPs policy rate, at this juncture, runs the risk of impeding the still nascent recovery, while a downward adjustment runs the risk of fuelling an already high inflation. Hence, SBP has decided to keep the policy rate unchanged at 12.5 percent.

OBJECTIVES
Objective(s) of SBPs monetary policy is to achieve price stability while keeping an eye on economic growth. Targets of average Consumer Price Index (CPI) inflation and real gross domestic product (GDP) growth are set by the government and announced prior to the beginning of a fiscal year. Monetary policy actions current as well as expected affect these variables, with a lag, through adjustment in aggregate demand induced by changes in interest rate and broad money (M2) expansion. The targets for CPI inflation and real GDP growth provide a basis for setting an indicative target for M2 expansion, which serves as an intermediate target. A practical reason to use M2 as an intermediate target is that this information is compiled by the SBP on weekly basis, whereas the information on other macroeconomic variables and sectors becomes available with a considerable lag. Available information on the components of M2 and their projections are used in understanding and analyzing interactions of the monetary sector with the real, fiscal and external sector of the economy. This helps in assessing the demand pressures in the economy relative to its productive capacity. The net foreign assets (NFA) and the net domestic assets (NDA) of the banking system are the two major components of M2. NFA is essentially

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determined by developments in the balance of payments and reserve accumulation/depletion. NDA is composed of the credit extended by the banking system to the government (for budgetary support as well as commodity operations) and the non-government sector (private sector and public sector enterprises) and the (net) other items. Thus, the projections of equilibrium money growth SBPs intermediate target have to be consistent with not only the projections of the external account and announced federal budget, but also the projected inflation path and the likely real GDP outcome. Thus, constructing monetary policy formulation is a forward looking phenomenon. Change in the monetary policy stance is signaled through adjustments in the policy rate. Importantly, not only the current behavior of economic variables is affected by a monetary policy decision but also the expected path is influenced via many channels. The changes in the policy rate are complemented by appropriate liquidity management mainly through Open Market Operations (OMOs) and if required changes in the Cash Reserve Requirement (CRR). These measures influence interbank and other market interest rates, starting with the overnight money market repo rate, which is the operational target of SBPs monetary policy. The policy rate (SBPs overnight reverse repo rate) serves as the effective ceiling to the money market overnight repo rate, while the rate on the new overnight facility (SBPs repo rate) provides a binding floor to its downward movement. Effective control of this rate within this corridor through calibrated liquidity management helps in influencing other market interest rates in a desired manner. The resulting changes in market interest rates and their expected path affects the consumption (domestic as well as imported goods consumption) and investment behavior (domestic and foreign) of economic agents, and other economic variables through a host of channels and thus influences the level of aggregate demand in the economy. Finally, the adjustment in aggregate demand affects the general price level and thus inflation. Both the current as well as the expected monetary policy stance are important in influencing the economic behavior and ensuring price stability. Implementation of an effective monetary policy assumes presence of an adequate transmission mechanism and absence of fiscal dominance.
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Economic Updates - Exclusive Articles

The primary objective of the monetary policy is to maintain price stability, contain inflation and formulate a policy that should help in bringing economic prosperity and welfare to the people by creating new jobs. Similarly on the administrative side, it is the responsibility of the government to contain inflation, if caused by supply shock through administrative measures.

Considerable decline in average Consumer Price Index inflation

State Bank of Pakistan

Chairing the panel discussion Ashraf Janjua, Ex-Deputy Governor (Policy), State Bank of Pakistan said that the SBP should make grounds towards moving for the single objective of the monetary policy that is price stability. He said that SBP has to be strong enough to stop excessive fiscal borrowings. He said that coordination and accountability is low between the two authorities. One of the reasons for inflation could be as the increase is the issuance of currency notes up to 60 percent of the MS increase, which was earlier only near 22 percent. Clearly by stating targets of growth, money supply and inflation the SBP is following an implicit rule, he added. Dr. Naved Hamid, Director, Centre for Research in Economics and Business, Lahore School of Economics said that he agrees with the MP stance and even suggested more tightening the policy. He said the SBP is really facing a pressure from the business community, government and others. But he pointed out that if SBP is unable to control government borrowing from SBP then the independence of State Bank will be at stake. Dr Fazal Hussain, Chairman Department of Business Studies, PIDE highlighted the monetary policy stance, its background and challenges. He raised a number of issues concerning the current MP stance from the academic and applied research perspective. He pointed out that rising inflation was envisaged in PIDEs Business Barometer for March 2007. He raised a concern about the monetary policy reaction function and highlighted the confusion about the rule/discretionary stance of SBP; where as a number of studies at PIDE have shown that rule is better in terms of achieving the objectives. Further, he highlighted that there is a time inconsistency problem with the current stance. He emphasized that there seems to be lesser coordination
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between the fiscal policy institutions and monetary authorities. He questioned the transmission mechanism, assumption of constant velocity, using a narrower indicator of monetary stance considering the large objectives it have i.e. MCI (monetary conditioning index) as compared to FCI (financial conditioning index) and market basing of monetary policy conduct. At the end of the panel discussion, Dr Abdul Qayyum, Registrar, Pakistan Institute of Development Economics thanked on behalf of PIDE, the chief guest, panelists and participants for their thought provoking discussions. He said that PIDE will continue to organise such discussions and seminars in future also.

COMMENTS
Monday, 17 May, 2010 | 02:05 AM PST | By Nasir Jamal
Pakistans chance of containing inflation in the 11 to 12 per cent band, as forecast by the State Bank of Pakistan (SBP) in its last monetary policy
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review, looks quite dim with the consumer price index (CPI) hitting 13.26 percent, a three month high, in April from a year ago. The CPI inflation during the year will be nearly 12 per cent, down from 20.77 per cent a year earlier, the SBP said towards end of March. On a monthly basis, inflation escalated 1.73 per cent from 1.3 Percent in March. The headline inflation has breached the governments budgetary target of nine per cent for the current financial year by a wide margin with CPI already spiking 11.8 per cent for the first ten months of the fiscal year to April. The average CPI inflation for the same period last year stood at 22.35 percent. Monthly core (non-food, non-energy) inflation also soared 10.6 per cent from 9.9 per cent in March. The (recent) rise in inflation is serious in nature, Asad Farid Khawaja, an economist at AKD Securities tells Dawn. Inflation will remain a major concern for the central bank, which will at best leave its key discount rate unchanged at current level of 12.5 per cent in its next monetary policy review later this Month even if it does not raise the credit cost. The SBP has been delaying monetary easing on the back of resurging inflation since November amidst worries about price pressures and expansion in fiscal deficit. Before that it had reduced its discount rate by 150bps to 12.50 per cent since July 2009. The bank had embarked upon monetary easing in April 2009 as inflation came down after peaking to above 25 per cent in October the previous year. Some economists insist the current bout of inflationary pressures is costpush, spawned by increasing prices of fuel, food, raw materials, transportation, construction materials, elimination of energy subsidies, etc as indicated by the spike the wholesale price index (WPI) for the last month. The WPI rose 21.99 per cent in April from a year earlier. The WPI was up 1.84 percent from March. With electricity tariff set to hike by six per cent from last month and little likelihood of the government passing on the reduction in global commodity prices, especially oil, to domestic consumers, the chances of prices coming down over the remaining two months of the fiscal year are slimmer, says Sayem Ali, economist for the Standard Chartered Bank in Pakistan. With the government printing money for financing its budgetary deficit the SBP has printed Rs171 billion since January onwards , it is fair to assume
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that the headline inflation will breach the State Banks 12 percent target by the end of this fiscal, Sayem said. The findings of a survey by the Pakistan Institute of Development Economist (PIDE) last week estimated the average CPI inflation to be above 14.50 per cent for the current financial year. Economists argue that it is imperative for the government to control its deficit financing needs in order to contain inflationary pressures in the economy. It (the governments borrowings from the central bank) does not look good, Sayem said, adding internal factors had set off the current spurt of inflation. The implications for the economy of high inflation over a longer period of time are quite obvious. It raises the credit price and stalls fresh investments in the economy, making a countrys exports uncompetitive in the international markets. At the same time, it also spawns deep uncertainty about future of the economy and affects consumer spending. People living off fixed-income find their purchasing power and their quality of life declining, says Asad. Apart from that it results in job losses and increased incidence of poverty Rising inflation in spite of a tight monetary stance being pursued by the central bank and implementation of an economic stabilization program has led to calls for easing monetary policy to push growth. What we need right now is growth. But that cannot be achieved unless we bring down the cost of credit to encourage fresh investments in the economy for job creation and poverty reduction, says Shahzad Azam Khan, a leading businessman from Lahore. He is critical of the governments economic policies that are suffocating the industry and making exports uncompetitive in the world. We have been taking dictation from the International Monetary Fund (IMF) for far too long and pursuing unfriendly business policies under its pressure that are stifling our industry. Its time we shifted our focus to growth from stabilization and cut the credit cost and reduce utility rates for encouraging investments and protecting jobs, industry and exports, he added. Unless you increase supply you cannot really hope to rein in cost-push inflation. We have tried it for the last three years and failed.

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Sunday March 28, 2010 By Saad Hassan

KARACHI: The State Bank of Pakistan (SBP) kept its key discount rate unchanged at 12.5 per cent for the next two months, saying that inflationary pressures and a widening fiscal deficit remains the biggest challenges for the country. The discount rate was last reduced by 50 basis points to 12.5 per cent on November 24 and since then has remained unchanged as the SBP struggles to curb inflation and ensure financial stability. Given the uncertainties pertaining to the fiscal and quasi-fiscal sectors, the present stance of monetary policy is striking a difficult balance between reducing inflation, ensuring financial stability, and supporting economic recovery, said the SBP Monetary Policy statement for April and May. An upward adjustment in the SBPs policy rate, at this juncture, runs the risk of impeding the still nascent recovery, while a downward adjustment runs the risk of fuelling an already high inflation. Hence the SBP has decided to keep the policy rate unchanged at 12.5 per cent. The SBPs decision was in line with the market expectations. Asif Qureshi, executive director of Invisor Securities, said monetary policy review had no surprises. We expect discount rate to remain the same even in the next monetary policy review due in May, he said. A reduction in discount rate is not possible before July, depending on inflows in the external account. To which extent these factors will influence other prices in the economy and expectations of inflation in the coming months difficult to assess. Partial phasing out of subsidies and reduction in development spending helped in containing expenditures but has led to a surge in domestic prices and is hurting crucial public sector investment. The SBP underlined the fact that the financing mix of the fiscal deficit seems uncertain. The external financing for budget, especially the part pledged by the Friends of Democratic Pakistan, has mostly been elusive.
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Of the Rs110 billion net external budget financing received during the first half of FY10, Rs93 billion were provided by the IMF The SBP expressed concern regarding the high borrowing by the Public Sector and bad loans of 22 and 17 per cent in the Small and Medium Enterprises and Agriculture sectors respectively, saying that it may lead banks to show reluctance to extend credit to the private sector. Khurram Shehzad, an analyst at InvestCap, said if government borrowing remains high, it could lead to a further tightening of the monetary policy in the next review. He said the country urgently needed at least $2bn in foreign financing to ward off liquidity crunch created by the energy-related circulated debt and commodity financing operations. It would not have mattered if the SBP had reduced the rate by 100bps or so because Kibor is still high and 1pc reduction adds just Rs30-35bn in the market whereas we need much more than that to bring down lending rates.

According to Muhammad Ashraf on 5/1/2009

Whilst the global economy is slowing down under the impact of the US subprime crisis, Pakistan has not remained immune from the suffering of the global turmoil. Pakistan's economic growth is declining sharply and according to International Monetary Fund, the economic growth is anticipated to be 2.5%. Liquidations, layoffs and job cuts are expected to continue. Currently, Pakistans economy is facing the threat of a prolonged recession. The situation is not merely for Pakistan only as according to a recent global survey, auditors report on 25% companies was not on going concern basis! Such an objective will gain the acceptance of the taxpayers, hence, the Government should ensure that the totality of governments treatment of its subject, its expenditures and its tax, is just. In achieving this, intuitive economists are of the view that the role of the government is to provide a favorable business environment to facilitate business development and free flow of capital, personnel and resources and to strengthen Pakistan as a preferred point of entry for investment flowing into the region. High interest rates are not co-related with inflation in excessive money supply economic environment and keeping the interest rates at current level or merely reducing it by 200 or 250 basis point would only defer the
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economic recovery of Pakistan. In the recent monetary policy statement, the discount rates were reduced by 100 basis points but contrary to that during the recent auction of treasury bills. One fails to understand the contradictions by State Bank of Pakistan! SBP must rely on strict control through prudential regulations and not through interest rates where most of the banks are operating in private sector. The existing TB rates are nothing but will increase the cost of deficit financing. It is really sad to state that role of EPB was an inactive body instead of a proactive body. EPB fails to identify the new exportable items and little has been done to promote cement etc. EPB fails to provide the exporter the data relating to competitive prices offered by neighboring countries and strategically making Pakistans export survive in competitive environment. Custom department of the FBR was busy in merely unearthing the under invoicing and misapplication of correct duty rates instead of providing any data compiled after due brain storming session to identify imports of items which are already available in Pakistan. The points discussed identify the key factors of current account deficit and reasons of loss in budgeted figures. It is high time that Unaligned Monetary and Fiscal Policies be aligned by having effective interaction among concerned ministries and organization that is FBR, SBP, EPB, SECP etc instead of individual heuristic approach. Consequently, the fiscal laws and monetary / fiscal regulators efforts need to be coordinated.

According to an independent economist and works for the Applied Economics Research Centre, University of Karachi at Tuesday, December 29, 2009 .
Pakistans current account balance improved considerably during the last fiscal year (2008-09) and continues to improve in the current fiscal year (2009-10) as well. As opposed to a deficit of $13.9 billion in 2007-08, or 8.3 per cent of the GDP, the current account deficit (CAD) shrunk to $9.3 billion, or 5.3 per cent of the GDP, in 2008-09 an improvement of $4.6 billion, or 3.0 per cent of the GDP. The CAD shrunk to merely $1.359 billion during the first five months (July-November) of the current fiscal year, as against $7.3 billion in the corresponding period of last year. A decline in the CAD implies reduction in macroeconomic imbalances. Both the Pakistani authorities and the IMF are happy, attributing this Improvement to the policies pursued by the government. Pakistans CAD shrunk to $9.3 billion in 2008-09 from a peak of $13.9 billion a year ago, thus showing an improvement of $4.6
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billion. This improvement took place for the wrong reason. Imports declined by 10.3 per cent in 2008-09, as against an increase of 31.2 per cent in 200708. Similarly, exports registered a negative growth of 6.4 per cent, as against a positive growth of 18.2 per cent a year ago. A careful analysis would reveal that the collapse in commodity prices owing to the global economic meltdown and the extraordinary surge in workers remittances for reasons still unknown, have played dominant roles in improving the CAD in 2008-09 as well as during the current financial year. As a result of the collapse in oil prices, Pakistans oil import bill declined to $9.2 billion from a peak of $11.8 billion a year ago, showing a saving of $2.6 billion. Similarly, a decline in the price of palm oil reduced the import bill by $226 million. Pakistan received $7.8 billion in overseas workers remittances Pakistan pursued tight fiscal and monetary policies to minimize microenvironment imbalance. For Pakistan, there is no room for complacency. It is not policy but the windfall gains that have reduced the CAD. For the IMF, the experts should not misguide Pakistani authorities by encourage complacency.

According to Sayem Ali country economist for Standard Chartered Bank SEP 29, 2009
After a turbulent 2008, the economy has seen a steady turnaround in 2009, and all major indicators are pointing to greater economic stability ahead, Foreign exchange reserves grew to $14.5 billion (covering 4.7 months of imports) in September from $6.5 billion a year earlier, helping to support the rupee. Headline inflation in August printed 10.7 per cent year-on-year, the lowest level in 18 months. Significant tangible gains have also been made in improving the security environment, including the successful conclusion of military operation in Swat. The S&P rating upgrade has accelerated a pickup in foreign investment in the equity market and nearly $275 million of investment has flowed into the stock market since June, reversing 18 months of capital flight. The significant build-up of foreign exchange reserves has also improved confidence in government paper. This indicates that the market is more confident in the governments repayment ability and is pricing in a lower risk of default. The pickup in inflation has forced the central bank to delay plans to ease monetary policy as it left its policy rate unchanged at 13 per cent in its last monetary policy review on September 29.High lending rates have discouraged private credit growth. Private credit has contracted by two per cent year on-year during the first quarter of the current fiscal. The ambitious government stimulus spending plan outlined in the budget is constrained by declining tax
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revenues, higher debt servicing costs, and delays in the removal of subsidies, the analysis says. Evidence suggests that there has been significant slippage, forcing the government to borrow Rs106.6 billion from the central bank during the first quarter to September. This is fuelling inflation and crowding out private investment through high interest rates. At the same time, resource constraints are forcing the government to shelve its own investment spending. In the given scenario, the analysis points out that fiscal reforms and official capital inflows are critical to recovery in the medium-term. Fiscal reforms to raise tax revenues and rein in unproductive expenditures are essential to creating the fiscal space needed for the government to make necessary investments in the power sector, scale up spending on the poor and limit the build-up of government debt.

According to Syed Kanwar Abbas

There is a consensus among economists that the gradual change in interest rate does not trigger much larger effects on the health of economy in the short run. The global economic perspectives now give impression that policy makers are willing to cut interest rates even at cost of higher inflationary pressures in the economy. the the the the

The Federal Reserve along with fiscal stimuli of $150 billion decided to cut the interest rate to 3 per cent in the presence of inflation at 4.1 in December 07 to counter US recession with the hope that all this will lead to stimulate economic activities in the economy. On the other hand, The European Central Bank is not planning to change its current interest rate of 4 per cent in near future though the higher euro zone inflation of 3.2 per cent is associated with the surge in food and fuel prices. The euro zone growth is not as highly volatile as compared to other larger economies. Similarly, the Bank of England is also expected to cut interest rates though inflation can exceed from its targets. Common to all this, these economic moves are linked up with the curative measures to overcome and/or absorb the expected severity of global financial crisis. In particular, the rise in the discount rate to 10.5 per cent by the Central Bank in recently released the monetary policy statement for the second half of FY-08 is not linked up with the recessionary period for the economy. The Central Bank is of the view that the higher inflationary pressures, widening fiscal and current account deficits are the major imbalances which led to the continuity of the tight monetary stance in the remaining half of the FY-08. However, it is also arguable that the measures of the Central Bank to reduce inflation would not work in full
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swing in the presence of higher prices of POL products and palm oil in the international markets. The economy remains under serious inflationary pressures. The current trend of higher inflationary pressures can have negative effects on the path of growth momentum for the economy. This requires curbing the growth of monetary aggregates which is targeted at 13.7 percent for FY-08. Therefore, the Bank continues its tight monetary policy operations in the MPS for second half of FY-08.

CRITICISM
Monday, 08 Feb, 2010 | 02:06 AM PST | By Nasir Jamal
Resurgent inflation pegged at around 12 per cent at the end of this fiscal year drove the State Bank of Pakistan on 30th of last month to keep its key policy rates unchanged on the higher side at 12.5 percent. Just a day before, Indias central bank had reacted differently to the threat of soaring inflation projected to rise to 8.5 per cent at end March from earlier estimate of 6.5 per cent. It hiked cash reserve ratio (CRR) by 75bps to suck liquidity out of the market. The key policy rate was kept unchanged on the lower side at 4.75 percent.

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The Indian response to the threat of inflationary pressures prompted critics of the SBPs tight monetary policy to renew their call for substantial reduction in the interest rates to support growth. If India can manage surging inflation through regulatory tools without throttling growth, why cannot we?, wondered a leading businessman who did not want to give his name. The tight monetary response to manage inflation has already brought the production sectors to the brink of collapse. But is the matter as simple as it appears on the surface? The two central banks are dealing with two different situations. Therefore, their response to the threat is also different, said an analyst. The objective of the RBI decision to raise CRR is to mop up excess liquidity caused by massive foreign private inflows from the banking system. India received foreign inflows of $40 billion in 2008 and $29 billion as of September 2009. Recently, China too had acted in a similar way and hiked CRR to suck excess liquidity of the market, the analyst pointed out. India and China, he said, have massive foreign exchange reserves which make them impervious to shocks. On the other hand, Pakistan is vulnerable even to the mildest shocks. We have very weak resource envelop and are largely dependent upon (foreign) borrowings. Even a mild shock like increase in global oil prices leads to erosion of our reserves and brings our exchange rate under huge pressure. Our financial position demands that we should manage the threat of inflationary pressures through monetary policy rather than through the use of regulatory tools, he argued. In its monetary policy statement, the SBP has cited resurgent inflation, fiscal slippages, pressures on the exchange rate and surge in global commodity, especially oil, prices as major factors behind its decision to maintain the status quo on the policy rate. It said risks to macroeconomic stability persist in spite of a visible improvement in the fundamentals. The most prominent risk to the macroeconomic stability is the uncertainty regarding availability of external financial inflows, which has deep effects on both fiscal and external current accounts sustainability. It also has implications for future trends in both the accounts and other sectors of the economy, it said. Another analyst insisted that the RBI decision to raise CRR indicated that the Indias central bank is ready to raise interest rates over the next few months. This is the beginning. At present the Indians are trying to manage inflation
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without hurting growth. But they will shortly be hiking their interest rates as well, he said. Another analyst, however, insisted that supply side shocks are responsible for distortions in price stability. The current inflationary pressures in the economy are being felt because of the hefty increase in energy prices as a result of cut in power and gas subsidies as well as the soaring global oil prices, he said. He was of the view that the SBPs tight monetary stance looks logical in the face of rise in the cost-pushed inflation. But the banks conservative approach would not significantly impact the inflation levels, which is a function of oil prices, he added. The risks to the macroeconomic stability notwithstanding, some analysts are expecting 50-100bps cut in the discount rates in the next monetary policy review. But others dont agree. If the recent declining trend in remittances does not reverse, the resulting resource gap and pressure on the exchange rate will constrain the central banks ability to reduce interest rates, particularly in an environment when rates are being hiked globally, a Karachi-based analyst said. Though it is difficult to disagree with the reasons that have compelled the SBP to continue to pursue a tight monetary stance in the face of growing criticism, the businessmen are running out of patience. There is no justification to keep interest rates that high particularly when this policy is unlikely to produce the desired results in the wake of costpushed inflation, said Gohar Ejaz, a prominent businessman who is currently heading the provincial organisation of the All Pakistan Textile Mills association (Aptma) in Punjab. The SBP policy is benefitting only the banks which are rigging profits at the cost of the industry and national economy. He said it is high time the government decided if it wants to turn Pakistan into a production economy. Our future lies in strengthening the production sectors. But that would require the government to make a decision and cut the cost of credit.Gohar wondered as to why the SBP is keeping interest rates high on the one hand and letting banking spread to rise above seven per cent. Whats the rationale behind letting the banks make money at the expense of their depositors as well as borrowers? Somebody has to explain it to the people who have suffered massively at the hands of the banks.

Tuesday March 30, 2010

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By Saad Hassan
About criticism of its tight monetary policy by the industry, the central bank said given the weakness in the countrys fiscal outlook and risks to external flows and rising inflation, policy options for Pakistan were limited. The SBP said trends in financial and capital accounts were discouraging as of the $3.7 billion surplus for Jul-Feb about $2.8 billion were recorded in the first quarter. Practically, all of the external financing was in the form of debt, significantly adding to the countrys vulnerability to external shocks, it said. The rupee also depreciated sharply between mid-December 2009 and midFebruary 2010 despite continued inflows from the IMF pushed up Pakistans foreign exchange reserves, the bank said.

Sep 12 2009, By Nasir Jamal

ISLAMABAD: Pakistan Institute of Development Economics (PIDE), a government-run institution, has pointed out ineffectiveness of the State Banks monetary policy to control inflation as ground realities present a more vulnerable scenario. The current monetary policy has virtually failed to achieve its objective of combating inflation, which has pushed up the cost of living and made it the most important problem in Pakistan, reveals Inflation expectation survey conducted by the PIDE. The decline in growth rate and decreasing currency value has led people to expect more inflation and massive increase in the joblessness. The middleclass income group is slipping fast into the poor class while vulnerability of the lower classes has further aggravated. Expected rate of inflation for March was 20 per cent and in April inflation is expected to remain the same. People expect, the survey shows, that in coming six months inflation will be on an average 21 per cent and the next year it will be much higher. Overall 53 per cent respondents indicate that next years inflation would be higher than the current year. The survey also reveals that both demand-pull and cost-push factors are responsible for current inflation in the country. Particularly, the global economic conditions are important contributors to inflation, followed by the food and oil prices.
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The survey says the current monetary policy is not effective to control inflation. It is suggested that corresponding monetary and fiscal policies are required to control inflation. The rate of unemployment in the next six months will increase in the view of 70.4 per cent respondents while 71.4 per cent respondents say that expectations about unemployment in next 12 months will also increase. Economic growth rate in the next six months is expected to drop according to 66 percent respondents. The exchange rate expectations in next six months will depreciate in the view of 43.8 per cent respondents whereas 35 per cent respondents say that there will be no change in the situation. As well as in the next twelve months exchange rate will depreciate in the opinion of 59.1 per cent respondents whereas 20.5 per cent respondents said there will be no change and 6.7 per cent respondents think it will appreciate. Half of the respondents have opinion that current rate of inflation is because of both demand-pull and cost-push factors, whereas 41 per cent believe that the current inflation is only due to cost-push. Most of the respondents (ie 81 per cent) express the opinion that the political scenario affects inflation expectations. International inflation, foreign aid and financial development also affect inflationary expectations. The current inflationary pressure in Pakistan in their opinion is due to the global financial crisis (39 per cent), followed by the food prices (34.9 percent) and oil prices (31 percent). The current monetary policy adopted by the SBP, according to 67 per cent respondents, is not able to control the rate of inflation. Majority of the respondents (86 per cent) believe that coordinated move by the Monetary and the Fiscal policy implementing authorities will help control current spell of inflation in the country.

According to the Federation of Pakistan Chambers of Commerce and Industry President, Sultan Ahmed Chawla:
The high interest rate would further push up the cost of production, which would definitely be transferred to consumers, adding to inflationary pressures rather than curbing inflation. This inflation is not demand-push, which can be controlled through a tight monetary policy. Instead, the major causes of rising inflation in the country are the hike in prices of oil, wheat
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and other food items. All these are inelastic products and the monetary policy cannot control their prices. Measures must be taken to improve the supply of these goods and improve our supply management. Economists have been arguing for an expansionary policy in this state of recession to control over the damaging effects on employment and investment. Businessmen and Industrialists have been extremely critical and opposed to the new monetary policy and have expressed concerns over the closure of industry owing to high mark up and the continued negligence of the business community. They argue that this step would further increase the cost of production and destroy the industries. President of the Karachi Chamber of Commerce and Industry, Anjum Nisar was of the opinion that Pakistan was fast on its way of becoming one of the most expensive countries of the world. Furthermore, the Central Bank maintained the discount rate to induce commercial banks to participate in TBill auctions. However, the hike in State Banks discount rate failed to induce banks into investment in treasury bills as banks chose to invest only in threemonth papers taking no interest in six-month bills and showing little inclination to invest in one-year papers. Recent SBP reports shows progress in overall economy of Pakistan but this progress linked with IMF and other loans. Economic progress and stability with the help of loans could not be sustainable. Such progress is indicator of further deterioration in economy. SBP also discuss the uncertainties of the sustained economic progress. It is important to adopt effective policy measures to tackle with forecasted threats to economy to achieve sustained economic growth. In the last twenty-two months the tight monetary policy chased by various criticisms both by business community and some of economists. Most of circles were of thought that worldwide the monetary policy in most of developed countries eased for the sake of investment due to financial crisis but Pakistan was opposite to this practice. Actually the socio-political and macroeconomic scenario of Pakistan is quite different from developed countries. Continuing political instability, rising social unrest, riots and protests, corruption of civil servants, bureaucrats and politicians all this in combine provide no surety and security to ease monetary policy in high inflation and continues borrowing from central bank. The dean of NUST Business School, Islamabad criticizes monetary policy in one of his article of daily newspaper of Pakistan "the News". He says that "SBP should consider and analyze various macroeconomic developments which are likely to unfold during the remaining period of the current fiscal year". He discussed various components of current economic situations and
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criticizes monetary policy in presence of such unstable and uncertain environment. He furthered quote that" no country has ever achieved sustained higher economic growth in the midst of a rising debt service burden" Hence either the monetary policy tight or easy it remains a point of criticisms and dissatisfaction among the economists, business and investment communities. Monetary policy changing depends on macroeconomic stability of Pakistan and this stability farther linked by various issues. However the rope of all these issues is strictly tied with one hook which is too much corruption of politicians. Various circles criticizing and highlighting the corruption of politicians clearly but unfortunately there is no immediate action. Pakistan is a country which built on the foundations of Islam and luckily it is the only country in the world which achieved on the name of religion Islam. The history of Islam has very transparent, accountable and noble leaders. After the Holy Prophet (P.B.U.H), Hazrat Abu-bakr-Siddique, Hazrat Usman Ghani, Hazrat Umer Farooq and Hazrat Ali all have showed exemplary good governances to all Muslims. There was equality of rights, there was democracy there was concept of open market and investment in their era. There was a proper banking system, judiciary system, and jail system and aid institute at state level to benefit poor in the name of Bait-ulmaal. Nowadays Pakistani Muslims are confused in such a way that they may not have any history to learn from and follow.

According to Dr Javed Akbar Ansari:

The State Banks Monetary Policy Statement for April to June 2010 is an eyeopener.: An upward adjustment in SBPs policy rate at this juncture runs the risk of impending recovery while a downward adjustment runs the risk of fuelling an already high inflation. Hence the SBP has decided to keep the policy rate changed. No justification is offered for the dogma that a reduction in the policy rate will enhance inflationary pressure. There is overwhelming evidence that this is not true and the near-zero interest rates in Japan, Europe and America in recent years have generated no inflationary pressure at all. The 40-word monetary statement shows that the State Bank cannot offer any justification for its monetary management. It has lost control over money
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supply especially changes in the NFA. It is quite incapable of reducing inflationary pressure. The year-on-year increase in CPI inflation has risen from 8.9 in October 2009 to 13.1 per cent in February 2010. Food inflation has doubled during this period from 7.5 in October 2009 (year- on- year) to 15 per cent in February 2010. The State Bank has cut back its financing of the fiscal deficit by Rs64 billion due to the IMF pressure but it has been unable to prevent a massive growth of commercial and NBFC public deficit financing which has amounted to almost Rs300 billion in the first half of this fiscal year. The State Bank has been unable to check the growth of domestic debt. Most of this is short-term (i.e. floating) debt. Debt service payments on permanent debt in the first half of FY10 were 60 per cent higher than in the first half of FY09.The interest payments to the IMF in the first quarter of FY10 exceeded total interest payments to the IMF during FY09 by 15 per cent. The external debt servicing to export earnings ratio will probably exceed 30 per cent at end FY10 and may be higher than in any year since FY05. The State Bank has no control over the inexorable build-up of foreign debt and liabilities and its associated service costs. It has no control over the services and income accounts of the balance of payments (During July to February 2010 payments on the income accounts exceeded receipts by 376 per cent). This shows that the SBP has emasculated itself and is now nothing more than a colonial currency board. The SBPs control over net domestic assets (NDA) is also weak. The SBP continues to operate a tight monetary policy despite clear evidence that this policy strangulates investment growth and thus fuels inflation. The SBP toes the IMF line and applauds the governments phasing out of subsides and reduction in development expenditure.

RECOMMENDATIONS
WB expresses optimism in improving current economic situation 'Pakistan Times' Business & Commerce Desk ISLAMABAD: The World Bank on Wednesday expressed its optimism that current Pakistans economic situation would start improving. I am optimistic that the current economic situation will be much better, the World Banks Country Manager for Pakistan, John Wall told media after
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assuming the charge of his office here today. He said that during 2002-07 Pakistan witnessed a boom in Gross Domestic Product (GDP) and also growth in income. He attributed the current economic situation in Pakistan to high international oil and agricultural commodity prices, which enhanced the import bill of the country. John Wall said that after 9/11 a high surge in the remittances of the country was noted. He said that low interest rates are necessary for the growth of business activities in the country. He also stressed the need for low inflation and low current account deficit and creating fiscal space for expenditure in social sector development like health, education and infrastructure development for the benefit of the people in the country. The Country Manager of the World Bank also called for competitive export regime and seeking market access and duty free exports for Pakistan in the Organization for Economic Cooperation and Development (OECD) countries for propelling exports for the prosperity of the country. John Wall expressing his dissatisfaction over Pakistans low tax ratio underscored the need for implementation of Value Added Tax (VAT) in order to document the economy and broaden the tax base regime for generating revenues for the benefit of the country. A lot of countries have implemented the VAT in their respective countries, he remarked. He also stressed the need for setting up small hydel power projects through private sector participation and investment for generating cheap and low cost electricity and overcoming energy crisis in the country. He also called for improving the efficiency and workings of the state owned enterprises like PIA, Pakistan Railways to improve their performance in terms of profit and services. Replying to a question, he said that the World Bank is open for extending loans to the Diamer-Basha Dam to Pakistan but with certain conditions. He called for improving the line losses of electricity in the country.

SBP MARCH 2010

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Government will have to revisit its commodity intervention strategy, sooner than later, so that commodity operation requirements may go back to normal levels. Similarly, a complete resolution of the circular debt would be essential. Apart from releasing banking system resources and easing pressure on market rates, it will alleviate some constraints impeding production of electricity in the country thus paving way for sustainable economic recovery. Given the uncertainties pertaining to the fiscal and quasi-fiscal sectors, present stance of monetary policy is striking a difficult balance between reducing inflation, ensuring financial stability, and supporting economic recovery. An upward adjustment in SBPs policy rate, at this juncture, runs the risk of impeding the still nascent recovery, while a downward adjustment runs the risk of fuelling an already high inflation. Hence, SBP has decided to keep the policy rate unchanged at 12.5 percent.

According to Bilal Sarwari June 12, 2009

Pakistans balance of payments came under severe pressure during fiscal 2007-08 and in the first four months (July-October) of the current fiscal year owing, to the unprecedented rise in oil, food and other commodity prices as well as to the global financial turmoil. Pakistan approached the IMF for balance-of-payments support and received a $7.6-billion package spreading over seven quarters, ending in June 2010. One of the objectives of the IMF programmed was to restore the confidence of domestic and foreign investors by addressing macroeconomic imbalances through tightening of fiscal and monetary policies. Tight fiscal policy was needed to curtail aggregate demand and support improvement in current account deficit. A tight monetary policy was needed to restore confidence in the Pakistani rupee, help rebuild foreign exchange reserves, ensure domestic financing requirement of the government is met through market placements of government securities and sharing off aggregate demand by reducing import demand for which higher interest rates were needed. It is important to note that while the rest of the world was pursuing easy monetary and fiscal policies Pakistan was pursing entirely opposite ones. This is because the rest of the world was facing the issue of lack of demand while Pakistan was facing the challenge of excessive demand as reflected through high fiscal and current account deficits. Fiscal deficit is expected to be 4.3 percent of GDP-down from 7.4 percent and the current account deficit
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is likely to be 5.3 percent of GDPdown from 8.4 percent last year. Such a sharp reduction in macroeconomic imbalances in one year is not a mean achievement. The suggestion is that we keep the budget deficit at less than 4.0 borrowing of the GDP level and continue to pursue a tight monetary policy for one more year and consolidate the gains. In other words, what we need is macroeconomic stabilitylow budget deficit, low current account deficit, and single-digit inflation. Growth will follow stability. In the meantime agriculture can contribute to growth; manufacturing and services will contribute to growth if we succeed in improving security environment and minimize power shortages. The present government will be presenting three more budgets during its tenure. One more year of tight monetary and fiscal policies will allow them to spend more in the remaining three budgets.

VAT imposition inevitable: WB By: Afzal Bajwa | Published: May 13, 2010
ISLAMABAD Value Added Tax imposition is a hard and fast condition of the World Bank as its Country Manager in Pakistan John Wall suggested mobilization of resources and stopping drainage of funds into the state owned entities. Wall who assumed charge on Wednesday as the Country Manager talking to a selected group of journalists on Wednesday said, I am optimistic that the current economic situation will get much better. But it should not be left to an automated pilot, he rushed to add. It needs close watch on both monetary as well as fiscal side. Answering a question about possible delays in imposition of the Value Added Tax he said, We would continue with the assistance to Pakistan as long as there are enough reasons to believe that it (VAT) would be implemented. He attributed the current economic situation in Pakistan to high international oil and agricultural commodity prices, which enhanced the import bill of the country. He said that low interest rates are necessary for the growth of business activities in the country. But the monetary policy needs to be tightened timely if the economy gets overheated as happened in 2005. Thus, he stressed the need for low inflation and low current account deficit besides creating fiscal space for expenditure in social sector development.
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Asked how the Government should curtail its expenditures, he said, a mammoth amount of Rs 3.5 trillion was stuck-up in throw-forward head of a variety of projects lingering at any stage much before completion.

May 18, 2010 By Syed Fazl-e-Haider

KARACHI, Pakistan The International Monetary Fund (IMF) released a US$1.13 billion loan to Pakistan at the weekend after the latest review of the countrys economic performance under an $11.3 billion stand-by arrangement (SBA) to help the South Asian country meets its overseas debt obligations. The IMF also granted the country waivers for overruns on the overall budget deficit and net borrowing limits from the central bank for the period ended March, 2010. The fund also agreed to combine the remaining three disbursements into two. Government Finance Adviser Abdul Hafeez Sheikh has indicated that Islamabad may apply for a second IMF loan program due to a shortage of resources caused by low tax collection, delays in aid from donors, and the cost of debt servicing. At the same time, he made clear his opposition to the cost of calling on IMF assistance. We may need a follow-up program but in the long run we have to get rid of the IMF because its expensive said he told a news conference last week. Critics say Pakistans foreign exchange reserves will continue to erode as the country lacks a strategy to deal with the ever-increasing cost of debt servicing. This reached $3.57 billion during the first nine months (July-March) the current fiscal year, against $3.55 billion for the entire previous fiscal year, and may exceed $5 billion by June 30, according to the central bank. Pakistan will receive the fifth tranche of $1.13 billion from the IMF on Tuesday, according to the State Bank of Pakistan. The IMF agreed to increase the end-June 2010 budget ceiling by 0.15% of gross domestic product (GDP) to allow space for urgent security outlays and to avoid spending cuts. The floor for net foreign assets of the central bank was raised by $300 million. The fresh disbursement will increase the countrys foreign exchange reserves, which stand at $15.357 billion, of which the central bank holds $11.552 billion.

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Release of the IMF loan will help to restore the confidence of the World Bank and Asian Development Bank (ADB), as both lending agencies require Pakistan to get a Letter of Comfort from IMF for obtaining any new loan. The loan was due by the end of March, but it was delayed due to disagreements between the fund and the government over the introduction of a value-added tax (VAT) and the raising of power tariffs. Under the IMF program, the country failed to meet an April 1 deadline for a 6% increase in electricity tariffs. Pakistani officials have assured the IMF of their commitment to proceed with legal and administrative steps to ensure that the VAT is introduced by July 1. Pakistans economic conditions have improved even though the country faces adverse security developments and a rapidly changing political environment, IMF deputy managing director Murilo Portugal said in a statement released from Washington last week. The IMF said the countrys economy remained highly vulnerable, and listed worry spots ranging from persistent inflation to security-related spending pressures. Real GDP growth has begun to pick up and the external position has strengthened. Preparations for important and politically difficult tax reforms have moved forward, and there has been steady progress in financial sector reform, he said. The economy is forecast by the finance ministry to expand by 3.4% in the fiscal year ending on June 30 after growing 2% in the last financial year, the slowest pace in eight years. With the release of the latest loan installment, the country has drawn about $7.27 billion from the IMF. Islamabad turned to the fund in November 2008 for a $7.6 billion rescue package, as the country grappled with a 30-year high inflation rate and fast depleting reserves that were barely enough to cover nine weeks of import bills. The loan was increased to $11.3 billion in July last year and the central bank received a fourth tranche of $1.2 billion on December 28. While industries battle chronic power shortages, with rolling blackouts countrywide, inflation is again rising, hitting 13.2% year-on-year in April, compared with 9% towards the end of last year. The countrys trade deficit increased to $12.24 billion in the first 10 months of this fiscal year, with $15.88 billion of exports against $28.12 billion of imports, according to the Federal Bureau of Statistics (FBS).

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Pakistan continues to suffer violence from al-Qaeda and Taliban militants, with at least 3,200 killed in acts of terrorism since July 2007. The United States released $656 million to the country from its Coalition Support Fund (CSF) for some costs incurred last year, with $188 million transferred on April 30 and another $468 million this month. Security-related spending, low revenue collection and a shortfall in aid promised by donors last year in Tokyo have been the main reasons for the countrys growing budget deficit, which may overshoot its target of 5.1% of gross domestic product (GDP), as agreed with the IMF. The implementation of VAT to replace a general sales tax (GST) by July 1 is one of the main concerns of the IMF. The fund wants the country to use VAT to raise its tax-to-gross domestic product (GDP) ratio by between 3 and 4%, as its current tax-to-GDP ratio of about 9% is one of the lowest in the world. Though Islamabad has indicated that VAT will be rolled out on July 1, analysts are skeptical about its impact because they say the government has not done enough to make taxpayers aware of what it entails. There are also unresolved differences between the provincial and federal governments over the mechanism for the collection of the tax. The federal government still appears in serious trouble in fulfilling its promise with the IMF to pass the draft VAT bill by May 31. Some analysts believe that taxpayers, since they have no idea how VAT would work, could resort to agitation and may even close down markets. Critics say imposition of VAT could spark widespread tax evasion. The provincial Sindh government has said the federal governments effort to impose VAT in its existing integrated shape would be a violation of constitution and that VAT on goods is the jurisdiction of the federal government while VAT on services as well as its collection is the right of the provinces. The Ministry of Finance contends that there is no option other than to impose VAT on both goods and services under the IMFs Standby Arrangement (SBA) program if Islamabad wants to complete the existing fund program. The government plans to increase the number of taxpayers from 1.9 million to 2.4 million after the implementation of VAT from July 1. The nonimplementation of VAT from that date has reportedly been identified by the government as the biggest risk for the revenue policy for the next fiscal year,
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as the county may face a serious revenue shortfall if the tax base is not broadened. Syed Fazl-e-Haider is a development analyst in Pakistan. He is the author of many books, including The Economic Development of Balochistan (2004).

Press release May 14 2010 Mr. Murilo Portugal, Deputy Managing Director and Acting Chair:
Nevertheless, Pakistans vulnerabilities remain high, due to persistent inflation, security-related spending pressures, energy-sector problems, and shortfalls in revenue collection and external financing. These challenges highlight the importance of pursuing a credible fiscal consolidation, maintaining a flexible exchange rate and a cautious stance to monetary policy, and improving governance. The authorities resolve to press ahead with the structural reform agenda will also be key.

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helplessness-on-rising-fiscal-deficit/
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http://www.chowk.com/articles/15994 http://www.grand challenges.html

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http://www.Pakistantimes.net Asia times http://www.IMF.org wizarat@cyber.net.pk

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