Increase draws sharp response

The monetary policy released by SBP criticises the government over its inability to rein in the fiscal deficit.

KARACHI: The monetary policy released by the State Bank of Pakistan (SBP) on Wednesday severely criticised the government over its inability to rein in the mushrooming fiscal deficit.

In the policy, the SBP increased its policy rate by 50 basis points to 13.5 per cent. However, economic analysts and private sector stakeholders also criticised the central bank for further increase in the discount rate.

A press release issued by the SBP warned that due to extensive floods in the country, “economic growth for FY11 could come down to 2.5 per cent from an earlier target of 4.5 per cent” because aggregate private consumption may decelerate. SBP also expects government expenditure to increase due to rescue and rehabilitation efforts that would lead to “a sharper deterioration of the fiscal accounts”. Recalling that the initial budget deficit of 4 per cent was revised to 5.2 per cent of gross domestic product (GDP) “after the combined provincial budgets were unveiled”, the central bank warned that “even attaining the deficit of 5.2 per cent of GDP will require considerable adjustment in the key fiscal parameters” from the government.

While most economic analysts had expected monetary tightening for the fiscal year 2011, many have been blindsided by the central bank’s decision to raise the discount rate at this juncture. BMA assistant vice-president Hammad Aslam said that the interest rate hike “comes as a surprise given that disaster assessment studies and clarity on foreign pledges will have to wait till next month”. Another analyst, Raza Jafri hinted that the central bank may have jumped the gun in its quest to counter inflation. “In the backdrop of increasing fiscal slippages and accompanied government borrowing, the SBP has preempted a higher inflationary trajectory by raising the benchmark discount rate,” said the AKD analyst. “By continuing with a hawkish monetary stance, the SBP has ignored significant risks to growth and has sidelined weak underlying demand,” concluded Jafri.

InvestCap head of research Khurram Shehzad minced no words saying, “The rate increase was unjustified, at least this time around”. He pointed out that inflation has been fueled mainly by “rising food prices which is a supply-side concern.” “Inflation may be even higher due to the leveraged position of the private sector which will pass on this higher cost through price hikes,” he said adding that, “growth will also be impacted by the higher cost of borrowing.”

“The decision is a response to the government’s inability to meet its commitments on checking fiscal imbalances,” commented an economist. “Furthermore, another hike is imminent if the government continues on the current path,” he said, adding that, “the implementation of the reformed GST will be difficult and if reliance is placed solely on it (GST) for improving revenues, then the fate of the next monetary policy review may already be sealed.”

SBP has stated that “difficulty to contain the fiscal deficit has resulted in the private sector bearing the full brunt of such an adjustment”. Experts have warned that an indication of the extent of this brunt may be seen in equity markets on Thursday.

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