KARACHI: In an attempt to boost private sector credit and investment, the State Bank of Pakistan (SBP) on Saturday slashed the policy rate by 150 basis points to 12 percent, but the expected rate cut proved much higher than its projections.
The decision came in the backdrop of a premature scrapping of the International Monetary Fund (IMF) programme by the government and dim prospects of any external assistance in the wake of Islamabad’s estranged ties with the United States on the country’s alleged support to an Afghan terror network.
“The direction of the cut in discount rates is correct, but the magnitude of correction is not,” said Dr Ashfaque Hasan Khan, dean of NUST Business School, Islamabad.
“Nowhere does a central bank increase or decrease the discount rate by such a high percentage,” said Khan, a former advisor to the Ministry of Finance.
“A reduction of 50 basis points would have been sufficient to give a signal to the market that the central bank is now easing its monetary policy,” he said.
While some analysts called the central bank’s decision a step in the right direction, others said it was politically motivated.
Muhammad Sohail, CEO, Topline Securities, said the move might put some pressure on the rupee, but the equity market and bonds would rally.
Analysts had already forecast an ease in the policy rate due to a cut in treasury bills yield, lower growth of inflation and encouraging revenue collection by the Federal Board of Revenue (FBR) during the first quarter.
A majority of the analysts had forecast around a 50-100 bps cut in the key rate, considering all the economic indicators.
The decision to reduce the policy rate was taken at a meeting of the central board of directors of the SBP held under the chairmanship of acting Governor Yaseen Anwar.
The decision was taken after taking some comfort from the declining inflation and high probability of meeting financial year 2012 inflation targets together with a need to support private sector credit and investment growth.
The SBP, however, said it will continue monitoring fiscal sector developments and those pertaining to foreign financial inflows to gauge risks for the macroeconomic stability.
Though inflation growth is apparently meeting the target of 12 percent in FY 2012, there are challenges in meeting medium-term inflation targets of 9.5 percent in FY 2013 and eight percent in FY 2014, the central bank said.
“These risks largely stem from persistence of government borrowing from scheduled banks, exchange rate depreciation, and likely upward adjustment in the administered prices of energy,” the SBP said.
In the last policy decision in July, the central bank reduced the rate by 50bps, considering improvement in fiscal positions. The SBP said that previous decision continues to show progress as the consumer price index and government borrowing from the central bank is lower than its end-June level.
Despite the rate cut, the central bank said risks to macroeconomic stability emanating from fiscal weaknesses and falling foreign financial inflows have not receded.
“Moreover, severe energy crisis and precarious law and order conditions continue to render domestic economic environment least conducive for productive activities,” it said.
“In addition, the likelihood of falling short of the annual GDP growth target has increased due to damaging impact of the recent floods in Sindh,” it added.
The rapidly deteriorating global economic conditions, especially in Pakistan’s export-destination countries, do not provide much confidence either. In these circumstances, balancing inflation and growth considerations through the monetary policy alone is difficult, the central bank stressed.
“Nevertheless, these risks can potentially mitigate if positive developments and intended policy actions take root,” the SBP said.
Firstly, it suggested to continue restrain on government borrowing from the SBP.
The latest provisional data shows that the outstanding stock of borrowing from the SBP came down to Rs1,051 billion by September 30, which is lower than the limit of Rs1,155 billion for FY12.
The SBP expressed hope that it would have a beneficial impact on inflation outlook if the trend continues.
Secondly, the government has decided to consolidate the outstanding inter-agency circular debt of energy sector and settle the unpaid subsidy claims on account of its commodity operations by issuing government securities of close to Rs400 billion.
“These measures would alleviate the energy sector’s financial difficulties leading to better utilisation of installed productive capacity and may release the stuck up resources of the banking system that can then be channelled to productive activities,” the Bank said.
Thirdly, led by the 50bps reduction in the policy rate announced in July, the market interest rates have come down considerably. The effect on corporate lending rates would become more visible in the coming months. This is expected to have a desirable impact on the demand for credit by the private sector over and above their working capital needs.
“The resulting increase in fixed investment may help the productive capacity of the economy, having a beneficial impact on inflation in the medium-term,” the SBP said.
The central bank stressed upon the need to fiscal reform for expansion in the private sector credit and investment in the economy.
“Especially, in the wake of declining external budgetary support, it is imperative to increase the tax-to-GDP ratio to scale down reliance on borrowings from the banking system,” the SBP suggested.
The government for the first quarter set the target of Rs750 billion borrowing from commercial banks through treasury bills. However, it raised Rs851 billion against the target.
The announced target for the second quarter is Rs1,025 billion, including Rs63 billion incremental requirements. Considering the trends, the central bank said the government may borrow more than the targeted amount.
The SBP said thet average annual inflation is likely to stay within the target of 12 percent. The year-on-year inflation in September comes down to 10.5 percent from 13.3 percent in June though month-on-month inflation is still more than one percent on an average.
In continuation of the fourth quarter of FY11 trend, the proportion of amount offered by banks in the 12-month tenor during primary auctions of the T-bills during the first quarter of FY12 increased to 63 percent from 25 percent in the last quarter of FY11, it said.
This noticeable shift in banks’ preference for the 12-month T-bills will help alleviate pressure on the government to rollover its short-term debt and indicate market’s expectation of inflation coming down.
“This may help to some extent in improving the supply of credit to the private sector,” it added. The monetary policy pinpointed the tight liquidity conditions amid a decline of $1.1 billion in the central bank’s foreign exchange reserves during the first quarter.