Discount rate raised to 13.5pc
By Shahid Iqbal
KARACHI: The State Bank once again increased the policy interest rate by 50 basis points, because of fears of higher government borrowing and inflation and lower economic growth and revenue during the current fiscal year.
According to a Monetary Policy Statement issued on Wednesday, the SBP increased the discount rate to 13.5 per cent. The rate had been increased by 0.5 per cent in the last monetary policy for August and September. The new rate will be effective from Thursday.
The statement said the recent catastrophic floods had serious implications for macroeconomic stability and growth prospects. Post-flood projections raise legitimate concerns about worsening of macroeconomic balances since the initiatives required to address the underlying cause for the primary stimulus to aggregate demand, coming from the fiscal side, are yet to be launched with vigour and coherence.
“Highly provisional estimates suggest that economic growth for FY11 could come down to 2.5 per cent from an earlier target of 4.5 per cent,” the SBP said.
It said there were signs inflation would increase further, accompanied by a drop in economic growth, both the trade balance and fiscal accounts would be under stress and the banking system might witness pressure because of an increase in non-performing loans of the private sector and borrowings of the government, unless a comprehensive and coordinated response was developed to meet the challenges.
Likely increases in electricity prices, induction of the Reformed GST and continued reliance of the government on borrowings from the SBP only added to the uncertainty surrounding inflation expectations, the SBP said.
The central bank said it might take two to three months for food inflation to return to the normal levels.
The government had increased its reliance on the SBP to finance the budget deficit, it said. It borrowed Rs220 billion during July 1-Sept 24, according to provisional figures, compared to Rs126 billion during the corresponding period of last year.
The government made heavy borrowing from commercial banks during the last fiscal.
The SBP said fresh borrowings from the banking system during FY11 would increase, especially if the spending requirements increased and there was no commensurate increase in tax revenues.
How the fiscal policy response to the floods was incorporated in the revised budget remained to be seen, but it was clear that even attaining the deficit of 5.2 per cent of the GDP would require considerable adjustment in the key fiscal parameters, it said.
“This entails substantial risks to economic stability in the immediate future and places a considerable pressure in the medium term on the already high debt burden of the country.”
Rising NPLs and relatively low private sector credit demand may provide incentive to the already risk-shy banks to meet government’s borrowing requirements at the cost of private investment in the economy.
This could make the task of reviving economic growth and bringing inflation down to single-digit level much more difficult.
The State Bank said the expected increase in the external current account deficit and uncertain foreign inflows could put pressure on its foreign exchange reserves and exchange rate in FY11.
“The components of the economic strategy that would need to continue to be in focus despite uncertainty would include implementation of tax reforms to enhance much needed revenues, resolution of the energy sector subsidies and circular debt to restore economic growth, relief measures for those affected by the floods, and containment of government borrowing from the SBP to restrict inflation,” the policy statement said.