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4th Quarter Monetary Policy Statement. Hopes and Fears

Mehmood-Ul-Hassan Khan

The governor State Bank of Pakistan announced the fourth quarterly Monetary Policy Statement. The SBP reduced the discount rate by 100 basis points to 14 per after a recorded/ reported sharp fall in inflation. According to the statement economy had made a steady progress towards macroeconomic stability.

The SBP adopted tight monetary stance in July 2007 aiming to curb inflation and shrink liquidity in the market and since then has raised its policy rate by 550 basis points to take it 15 percent. Last year November the IMF forced the SBP to increase the discount rate by 200 basis points to 15 per cent. Furthermore, the projected average consumer price index inflation for 2008-09 is around 21 per cent. The SBP hoped that said inflation was expected to decline to around 14 per cent in the April-June quarter of 2008-09 and to 8 per cent in the next financial year.

Main Characteristics

(a) The private sector was expecting a reduction in discount rate by 200 to 300 basis points after a massive fall in credit growth. According to the statement the private sector credit growth was at 14 per cent of what it was during 1.9 per cent of projected GDP for the first half of FY09 and the government’s commitment to cap it at Rs562 billion 4.3 per cent of projected GDP for the entire FY09 was a significant improvement over last year’s 7.4 per cent.
(b) Fiscal deficit of Rs 251 billion 1.9 percent of projected GDP for H1-FY09 and the government commitment to cap it at Rs 562 billion 4.3 percent of projected GDP for the entire FY09 is very significant improvement over last year’s 7.4 percent.
(c) External current account deficit had narrowed down to $172 million in March 2009, as against $2.2 billion in October 2008. Cumulative external current account deficit for the first nine months of FY09 stood at $7.6 billion and it was projected at $9 billion or 5.5 per cent of whole year’s GDP.
(d) Despite substantial improvement in the outlook of many important economic indicators, sustainable mediumterm recovery was still a challenge.
(e) Expected inflation of 14 percent for fourth quarter-fiscal year 2009 and 8 percent for fiscal year 2010 illustrates a positive outlook
(f) Easing of the monetary policy stance may not be sufficient to fully revive the private sector credit and thus the growth prospects.
(g) Dismal performance of large scale manufacturing (LSM) in July-February, FY09 with negative growth of 5.7 percent, and weaker than target growth of agriculture sector point towards the weaker real economic activities of commodity producing sector for FY09.

Main aim of easing monetary policy

The interest rates were at higher side. The business community demanded the reduction of interest rates. The economists were also in favour of reducing of discount rate so that to some extent economic activity could be re-started. The SBP announced relaxation in its tight monetary policy with an aim to provide relief to the country’s crises-hit economy. Almost all economic indicators have positively responded and the decision to reduce the key policy rate has been taken on the basis of the assessment that inflation will continue to decline.

Reduction in inflation

High inflation has been remained main concern for the government for many years. It is still a serious threat to our economy. According to the latest monetary policy statement the CPI inflation (Year-on-Year), is still higher than desired, but has declined to 19.1 percent in March 2009 from a high of 25.3 percent in August 2008. Persistent demand pressures, as depicted in core inflation measures, have also eased, he said adding that the 20 percent trimmed core inflation has come down by about 2.4 percentage points from its peak in October 2008. Although the projected average CPI inflation for FY09 is around 21 percent, expected inflation of around 14 percent for Q4-FY09 and 8 percent for FY10 illustrates a positive outlook. Moreover, fiscal deficit is also narrowing down due to the improved fiscal discipline and contraction in the external current account deficit. It will help narrow the output gap and strengthen the positive outlook for inflation.

YOY inflation
8-Jun 8-Mar 9-Mar
CPI 21.5 14.1 19.1
Food group 32 20.6 19.7
Non-food group 13.8 9.4 18.5
Non-food non-energy13 9.3 18.5
20-percent trimmed 17.2 11.3 19.3

Average inflation
Jul-Jun Jul-Mar
FY08 FY08 FY09
Headline CPI 12 9.5 23
Food group 17.6 13.8 27.8
Non-food group 7.9 6.3 19.2
Non-food non-energy 8.4 7.1 17.9
20-percent trimmed 10.2 8.7 20.4

12m MA inflation
July-June April-March
FY08 FY08 FY09
Headline CPI 12 8.9 22.1
Food group 17.6 13 28
Non-food group 7.9 6 17.6
Non-food non-energy 8.4 6.7 16.5
20-percent trimmed 10.2 8.4 22.6
Federal Bureau of Statistics and SBP

Reduction in current and fiscal twin deficits

The containment of twin deficits current and fiscal has reduced demand pressures and helped to enhance the investment capacity of the economy with the limited availability of foreign and domestic savings. It would create strategic cushion for the government to start mega projects of people’s welfare in the country.

Reduction in government’s borrowings

The SBP was succeeded to restrict the government borrowing from the SBP. It has restricted reserve money creation in the system which is still at lower side but gradually improving, foreign exchange reserve position. Furthermore, rise in SBP’s foreign exchange reserves of $4.3 billion between November-April, FY09 and projections that this level will increase to $9.1 billion by end-June, 2009 is also a key indicator of emerging macroeconomic stability too.

Liquidity (M2)

According to the monetary policy statement overall liquidity (M2) in the economy remains tight. The equilibrium growth rate of M2, consistent with projections for fiscal and external current account deficits, is expected to be around 8 percent or half of that in the comparable period last year. A significant source of M2 slackness has been the fall off in private sector credit demand. Total private credit growth for the last 9 months has been only Rs 48 billion, versus Rs 345 billion for this period last year. Private credit growth during July-March had been only Rs48 billion, as against Rs345 billion during the same period last year. As a result, banks built up an excess liquidity of Rs410 billion or about 10 per cent above their reserve requirements. It has allowed comfortable accommodation of government rollover of maturing bills Rs1,475 billion being bid against Rs700 billion accepted bills.

Deceleration in monetary

The deceleration in monetary aggregates poses two interrelated challenges

(a) The burden on the banking system to cater to the needs of various sectors, including government’s demands/borrowing. It would test the ability of domestic banking industry to match the incremental credit demand coming from the government to meet budgetary requirements and finance the commodity operations. Moreover, the wheat procurement cycle has begun and preliminary estimates indicate that there would be new credit demand of approximately Rs 60 to Rs 80 billion, on flow basis, for this purpose by the end-June, 2009.
(b) It is feared that as the growth of the banking system deposits remain weak and the injection of fresh reserve money is constrained, the already dwindling credit to the private sector might be squeezed further.

Expected implications

It is expected that the impact of these developments would be an upward pressure on interbank and other market interest rates such as KIBOR and T-bill yields. The weekly weighted average overnight repo rate, which averaged 11.25 percent during Q3-FY09, has moved upwards reaching 12.86 percent during Q4-FY09 up to the week ending April 17, 2009. However, improved inflation expectations are indicating that the market is anticipating lower interest rates in the near future. Therefore, it seems likely that the market will continue to operate smoothly.

Expected challenges

Despite positive outlook for inflation, the real challenge here is to improve the business climate in the country. Deteriorating law and order situation would be a serious problem to attract more FDI or initiate any mega joint venture in the country. The demand for credit by the private sector reduced sharply and the supply of credit by banks has also remained subdued, and the two emerging issues are difficult to disentangle. Ongoing energy crisis has slowdown the domestic economic activity throughout the country. The global economic recession and financial shortage would also be one of the main hurdles in our economy.


(a) The commodity producing sector, services sector is also likely to show a weaker growth in FY09 compared to FY08. However,
(b) Agriculture sector is expected to register a growth of 3.0 percent due to better output of major crops in Kharif season particularly of rice and cotton and expected bumper crop of wheat of around 23.5 tons.
(c) LSM sector growth, in particular, the performance of export driven industries particularly, textiles has been negatively affected amid energy outages, deteriorated law and order condition, and most critically, weaker external demand due to the recessionary tendencies in most of the major trading partner countries. It will be at lower side in 2009.
(d) Services sector is also expected to register a slower growth than the target of 6.1 percent for FY09. As a result, the prospect of overall growth remains modest and the economy is expected to register a growth of 2.5 to 3.5 percent in FY09, the SBP.

Views of business community

According to different businessmen, the monetary policy is a major cause of slow growth in the industrial sector and widening of economic inequalities during the last few years will be the last nail in the coffin of industrialisation. They were of the view that the monetary policy was one of the major hurdles in transferring effects of economic growth to the lower segment of the society through enhancement of employment generating activities. It is predicted that even common borrowers would also face the burden of tight monetary policy at a time when the industry, businessmen and common people were looking for a major relief in the discount rate.

The business community termed the cut in discount rate of 100 basis points by the SBP in the Monetary Policy as not sufficient for the revival of the depressed economy. President of Karachi Chamber of Commerce and Industry (KCCI) that the industry was already suffering from many hurdles like high cost of doing business and this nominal reduction in discount rate would not be able to revive or boost the industry. He said that controlling the economic crises through monetary measures was not going to be effective. Chairman SITE Association of Trade and Industry said that it is an irrational decision and this step would not decrease the high cost of production and unemployment ratio. Even all the chambers of commerce and industry rejected the latest monetary policy statement and strongly demanded more slashing in discount rates.

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