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Central bank moves to fight inflation, stabilise currency: SBP raises interest rate by 2 percent

* Foreign exchange reserves of $6.9 billion can only meet nine weeks of imports
* Government expenses more than available resources
* Current account deficit during last four months $5.9 billion dollars

By Mushfiq Ahmad

KARACHI: The State Bank on Wednesday spiked its interest rate by 2 percent in a bid to control demand pressure that has pushed inflation to 25 percent.

Announcing the decision at a press conference, State Bank of Pakistan (SBP) Governor Dr Shamshad Akhtar said the increase in the bank’s key discount rate was aimed at curbing inflation, reducing the current account and fiscal deficits, building reserves and calming sentiment in the foreign exchange market. The current account deficit has virtually doubled in the first four months of the 2008/09 fiscal year to October to $5.9 billion compared with $3 billion last year.

She said the central bank would fully refinance future loans provided by banks under the export refinance scheme and long-term financing facility, to soften the impact of the increase in the discount rate on exports.

“It was not an easy decision,” she said, and denied that the decision had been made under pressure from the International Monetary Fund (IMF).

The governor said Pakistan’s macroeconomic fundamentals were different from developed countries where interest rates were being slashed. She said the depreciation of rupee was a phenomenon of macroeconomic fundamentals.

She said a tightened monetary policy was needed to also deal with the imbalance in the country’s foreign payments, also called the external sector. She said the economic outcome in the fiscal year 2009 had ‘somewhat deteriorated’ from targets, while fiscal slippages had been ‘more acute’. She said the central bank had to finance external current account deficits from foreign exchange reserves because there was ‘no other option’.

Shamshad said the current level of foreign exchange reserves, $6.9 billion, could cover only nine weeks of imports. She said the import bill had risen by 35 percent in the first four months of the current fiscal year, compared with last year. She said that the high prices of oil are the chief reason behind high import payments, but conceded that non-food and non-oil inflation had also increased.

The impact of international oil price hike, the spike in the electricity tariff and the increase in general sales tax had all contributed to consumer-price inflation, she added.

Shamshad said the country needed to build up foreign exchange reserves to restore international investor confidence. She said that in addition to the oil payments, debt repayments and Haj-related expenses had also contributed to the deteriorating external sector. She went on to admit that foreign inflows had fallen and foreign-direct investment was drying up.

She said the steps taken by SBP had helped inject Rs 320 billion in the banking system so far.

Shamshad said the rise in Karachi inter-bank-offered-rate showed the market had already anticipated the discount rate hike, and the rate should therefore not go up any further.

She said the public sector spendings continued to increase in the absence of adequate resources – which had necessitated government borrowing from the central bank. The government had already borrowed Rs 369 billion from the bank this year – which included Rs 128 billion on account of maturing treasury bills, she said, adding that banks had under-subscribed government securities over the last few auctions and, as a result, the administration had to use the State Bank’s discount window more often. She said the persistent inflation had hurt the industrial sector by pushing input costs up.

The central bank chief said the liquidity stress on the banking system was being compounded by the Eid-related withdrawals and higher borrowing triggered by the spike in the private sector’s input costs. She said that withdrawals triggered by rumours related to the economy were also not helping the situation.

Analysts believe interest rates probably needed to go up sharply if Pakistan was to enter an IMF programme. “The hike in interest rate is likely a precondition to securing an IMF programme,” Reuters quoted Asif Qureshi, head of research at Invisor Securities Ltd.

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