No change expected in the State Bank policy rate

[Naveed Yaseen]

By Nasir Jamal
The State Bank of Pakistan (SBP) is unlikely to cut its key policy rate as demanded by businesspersons to stimulate investment and economic growth when it reviews monetary policy for the second half of this fiscal to June towards the end of this month, most analysts believe.

But given the recent decline in core (non-food, non-energy) inflation -- however insignificant it may have been --, they argue, the bank is expected to avoid pushing the rate as feared by many, and dampen growth outlook any further.

“Core inflation declined -- though only marginally -- for the first time since May 2007 to 18.8 per cent in December 2008 from 18.9 per cent the previous month. That is a positive development in many months.

Inflation is expected to continue its downward spiral during the rest of the current fiscal on the back of contracting domestic aggregate demand and sharply falling global commodity markets, particularly crude and food prices, thus curtailing the space for further tightening of the monetary expansion to curb aggregate demand,” says a capital market analyst based in Karachi. He says the decrease in core inflation has raised the prospects of reversal.

Along with core inflation, the headline inflation (including energy and food inflation) based on the Consumer Price Index (CPI) also fell to 23.3 per cent in December from 24.7 per cent in November. Though CPI has consistently been declining from its highest 25.3 per cent this August, core inflation was refusing to respond to the aggressive tight monetary stance being pursued by the bank for over three years now.

The central bank has been a target of broad-based criticism from the manufacturers for raising its key policy rate by 5.5 to 15 per cent since July 2007.

The manufacturers argue that the rising credit price has sharply increased their cost of doing business and made their exports uncompetitive in the international markets at a time when the global demand is receding owing to financial crisis followed by severe economic recession in the developed economies. They insist that the bank should adopt an easy monetary stance to restore their international competitiveness and push production and economic growth.

The large-scale manufacturing (LSM) - which contributes 13 per cent to the GDP (gross domestic product) posted a negative growth of 6.4 per cent during the first quarter of the ongoing financial year to September. The industrial output is feared to drop significantly during this fiscal as the manufacturers, especially the textile and automobile sectors, claim up to 50 per cent decrease in production.

The last time the bank enhanced its policy rate by two per cent was in November, days before the International Monetary Fund (IMF) approved Pakistan’s Macroeconomic Stabilisation Programme and released the first tranche of $3.1 billion. The release of the first IMF loan tranche helped the government ease pressure on the exchange rate.

Analysts anticipate a reversal of the tight monetary policy in the last quarter of this financial year to June as inflation continues its downward spiral over the next some months. “I would like to see the bank cut its policy rate now. But that does not appear feasible in the given circumstances when the government is implementing its macroeconomic stabilisation policies under the oversight of the IMF,” says another Karachi-based analyst working for a major brokerage house.

He, however, is hopeful that “things would normalise during the last quarter of the financial year as the economy has started showing signs of improvement in some areas”. The expected downward revision of the interest rates should boost economic activity and push growth next fiscal and beyond, he says.

Yet there are economic experts who still anticipate further increase in the central bank’s discount rate - for different reasons though. Dr Hafiz Pasha, who heads the Panel of Economists that drafted Macroeconomic Stabilisation Plan, told a seminar last week that there exists a possibility of rise in the central bank’s policy rate in the coming days, saying “core inflation is showing no signs of let up and there is yet no end of impact of hangover of unprecedented monetary expansion in the previous year”. He also did not rule out the rupee coming under more pressure in the coming weeks as oil transactions have to be market-based under the IMF loan conditions.

But there are others who warn against making any “positive or negative” forecasts on the basis of economic data available for the first half of the year. “It is too early to say anything at the moment. If we want to make any reasonable assessment of the state of the economy and predict future trends, we should wait for the economic data for the third quarter of the current financial year to March. That will tell us the direction of domestic and global trends and help in forming a realistic assessment of the economy,” says a senior federal finance ministry official.

Some economic experts also agree. “Well, inflation is moderating. But we don’t yet know if it represents a long-term trend or is a temporary phenomenon. Similarly, the current account gap during the first five months of the year to November has expanded to $6.855 billion from $4.745 billion a year earlier. We don’t yet know how much the reduction in global commodity prices is going to help bridge this gap as exports are also slowing down on account of international recession,” says an economist working for a leading private business school in Lahore.

The economic data available so far shows that the government’s fiscal deficit is down to one per cent of the GDP in the first quarter from 1.5 per cent last year because of abolition of power and food subsidies and huge reduction in the development expenditure, which are curtailed by 65 per cent.

On the other hand, the government’s current expenditure has increased by more than eight per cent to Rs427 billion. And the net foreign investment of $2.13 billion up to December is marginally lower than $2.16 billion of the same period last.

Foreign investment too is feared to remain far below the expectations ($5 billion) of the government and exports are likely to miss their target by a wide margin. The improvements in some areas are not because of any structural changes in the economy,” he notes.

“Therefore, it would be imprudent to draw any definite conclusions about the recent improvements in some areas of the economy, or success or failure of the macroeconomic stabilisation policies at this juncture,” the economist cautions.

http://www.dawn.com/2009/01/19/ebr2.htm