SBP increases policy rate to 13.5 per cent

Spiral­ling inflat­ion in the countr­y forces SBP to increase interest rate to 13.5 per cent.

KARACHI:

The State Bank of Pakistan (SBP) on Wednesday announced an increase of 50 basis points in its benchmark policy rate in a bid to tackle inflation that has affected the entire economy.

Announcing the bi-monthly Monetary Policy Review, the central bank said the decision to increase the interest rate to 13.5 per cent was taken at a meeting of the central board of directors of the State Bank held under the chairmanship of Governor Shahid Hafeez Kardar. This is Kardar’s first policy announcement since he assumed office earlier this month.

The interest rate rise, which will be effective from September 30, caught analysts off guard, many of whom were expecting the central bank to leave the rate unchanged.

“The monetary policy stance is formed by the consideration that the impact of continued inflation is substantial and felt by the entire economy,” the SBP said. It said the private sector is bearing the brunt of the interest rate hike because of the difficulty in containing the fiscal deficit.

In 2009-10, the fiscal deficit was 6.3 per cent of gross domestic product, substantially higher than the target of 5.1 per cent. This year too, the gap is expected to be above 6 per cent.

The bank hinted that further increases in the policy rate may be on the cards. “The next quarter will be crucial in forming an assessment of the effectiveness of government efforts to contain fiscal deficit and its inflationary borrowings from the SBP and the banking system.”

The policy decision manuscript explained that food inflation in recent months spiked beyond historic levels due to the floods. “It may take two or three months for food inflation to return to normal levels,” it added.

In its previous policy review at end-July, the central bank had increased the policy rate by 50 basis points to 13 per cent, after an earlier easing was interrupted by spiraling inflation. Although analysts had been expecting stagnation in the policy rate for now, the SBP cited that “in the aftermath of the floods, bringing inflation down to single digit will require a supportive and sustained financial and fiscal effort over the next couple of years.”

The bank also said that “to finance the budget deficit the government has increased its reliance on the SBP,” adding there was no commensurate increase in tax revenues for the government to balance its rising expenditures.

The bank warned that the federal government’s over-reliance on borrowings from the central bank could mean further monetary tightening in coming months, which will likely raise tempers of an already burdened private sector.

Published in The Express Tribune, September 30th, 2010.