Both Pakistan and India witnessed their economies growing faster during the last fiscal year and are now determined not only to maintain the current pace of growth but also to accelerate it.

Pakistan's economy grew by an estimated 6.4 per cent in fiscal year July-June 2003-04, up from 5.1 per cent in 2002-03.

The pace of India's economic growth doubled to 8.1 per cent in fiscal year April-March 2003-04 from the revised estimated growth of 4 per cent in 2002-03. Now, both the State Bank of Pakistan and the Reserve Bank of India are trying to contain inflation that has popped up during the course of high economic growth.

This has become necessary to ensure that a fast-paced growth of the two economies does not take its toll on the poorer sections of their population and that their poverty reduction programmes do not get affected.

In Pakistan, consumer inflation went up to 4.57 per cent in the last fiscal year; in India, it rose by 3.9 per cent. Pakistan's inflation at 4.57 per cent was much higher than 3.1 per cent in 2002-03. But India's 3.9 per cent was closer to 4 per cent in 2002-03.

So, whereas Pakistan is trying to ward off inflationary expectations after having received evidences of higher inflation in the wake of faster economic growth, India is doing in anticipation of the same thing.

On July 21, SBP issued its monetary policy statement for the first half of the current fiscal year i.e. July-December 2004. The central bank said in its policy paper that it would "continue to exercise vigilance on the movement of key variables and make a smooth transition from an expansionary monetary policy stance to measured tightening to avert inflationary pressures and maintain stability in exchange rate."

"This measured response will have to ensure that the current growth and investment momentum in the country is not impaired in any significant manner, export competitiveness is maintained while inflation is kept under control."

The central bank indicated in its policy statement that it would allow a gradual increase in the interest rates to check rising inflation. It further said that due to problems in external account, the rupee might also remain under pressure. So, whereas interest rates are going to rise, the rupee seems set to weaken during the first half of the current fiscal year.

To reinforce its policy statement, the State Bank raised the weighted average yield of six-month treasury bills by 45 basis points to 2.52 per cent the same day when it announced its monetary policy.

In fact, the central bank had started increasing T-bills yields since the middle of February 2004 in response to indications that inflation would move up faster than anticipated.

It had also minimized its intervention in the inter-bank market since March 2004 and let the rupee fall against the US dollar in response to the rising demand for foreign exchange on the back of soaring trade deficit.

The rupee shed 71 paisa or 1.2 per cent of its value against the dollar between April-June 2004 as trade deficit during this period reached1.622 billion, more than half the total deficit of $3.2 billion in last fiscal year.

The 45bps increase in the six-month T-bills yield in July increased the export refinance rate from 2 to 2.5 per cent. As a result, the maximum mark-up on export financing went up from 3.5 to 4 per cent in August. (Banks are free to charge a maximum spread of 1.5 per cent over the export refinance rate while pricing export loans for eligible exporters).

This was the first increase in export refinance rate of this fiscal year. But surely it will not be the last one. The reason is, as the SBP monetary policy statement indicates, the SBP would continue to raise T-bills rates gradually to rein in inflation and that, in turn, would push up monthly export refinance rates that are linked with the weighted average yield of six-month T-bills.

This, of course, would raise the financial cost of production and make it difficult for the exporters to remain competitive in the world markets. In that case, meeting the $13.7 billion exports' target set for this fiscal year may become difficult.

But on the other hand, the exporters would benefit from ongoing depreciation in the rupee value. The rupee has lost 80 paisa or 1.4 per cent of its value against US dollar between July 1 and August 4, 2004 because of the widening trade deficit and rising corporate demand for foreign exchange to clear their external liabilities. (In the entire fiscal year 2003-04 it had depreciated by 31 paisa or a little more than half a per cent of its value against the dollar).

Indications are that the rupee may fall further in the months to come, as trade deficit would continue to expand and foreign exchange outflows would rise due to a fast-paced liberalization of foreign exchange regime.

Pakistan has projected $3 billion trade deficit for this fiscal year, targeting imports at $16.7 billion and exports at $13.7 billion. But economists say as the country braces for a high growth target of 6.6 per cent and as global oil prices keep rising, the deficit may reach $3.6-$3.8 billion.

A gradual rise in the export refinance rate coupled with a depreciating rupee may lead most exporters to increase their foreign currency borrowing from banks. The banks too, may find it feasible to lend more in foreign currencies as their foreign currency deposits keep swelling.

In the last fiscal year, fresh foreign currency deposits or the deposits raised by banks after the freezing of $11 billion deposits in the wake of the May 1998 nuclear blasts, grew by $375 million or 16 per cent to $2.67 billion. Bankers say these deposits continue to grow. Figures for growth in these deposits in July are yet to pour in.

INDIA: The Reserve Bank of India had announced its monetary policy statement on May 18 2004 outlining salient features of its policy stance during this fiscal year (April-March 2004-05.)