ISLAMABAD, Aug 26: The real challenge before the State Bank is to manage the rise in interest rates in such a way that it does not thwart the ongoing economic recovery, says the Asian Development Bank (ADB).

It also believed that with the economic recovery gaining momentum, prices, interest rates and the exchange rate will come under pressure. Both the inflation and interest rates have bottomed out and the rupee has depreciated in recent months, as the trade deficit increased and the current account surplus declined sharply.

In its latest report - Pakistan Economic Update (July 2003- June 2004) - the ADB said that as economic recovery gains strength, prices, interest rates and exchange rate will come under greater stress.

"The management of the economy will become more complex as the government moves away from focussed pursuit of macroeconomic stabilization to balance the imperatives of growth and stabilization," it added.

At the same time, the government, in financing the fiscal deficit, will have to find a balance between excessive domestic borrowing crowding out credit for the private sector, and excessive external borrowing eroding the gains of the last few years in debt management.

"The government will also have to contain its borrowing requirements by mobilizing adequate revenues by consistently moving forward with taxation reforms, as well as improvements in tax administration."

"Finally, the State bank will have to use the exchange rate to keep the growing deficit in the trade account under control, instead of the government using tariff and non-tariff measures to restrict imports.

The bank also believed that reforms in the agriculture sector stalled due to various actions taken by the government in recent months. One of the objectives of the economic reforms pursued by the successive governments has been to curtail the role of the public sector and encourage private sector participation in the marketing for agricultural outputs and inputs.

Marketing of fertilizers and pesticides has been completely privatized, while both the public and private sectors operate in the seed market. However, recent policy actions have left the private sector participants guessing about the direction of the policy.

At the beginning of the wheat harvesting season, the government of Punjab banned the inter-provincial and inter- district movement of wheat, and conducted raids on flour mills and storage facilities of traders and confiscated the wheat purchased by them. Midway through the season, State Bank imposed a 50 per cent cash margin requirement for bank loans to traders and flour mills against wheat.

"Both the actions were meant to increase public sector purchases of wheat at the expense of the private sector. These interventions depressed the prices of wheat received by wheat growers in Punjab, and discouraged private traders and millers from making longer-term investment in badly needed areas such as storage and handling facilities."

At the same time, it gave signal to the market that storage was much larger than expected and promoted hoarding and an excessive increase in market prices of wheat in Punjab, resulting in windfall gains for hoarders. Also, the prices of wheat rose sharply in the wheat deficient provinces of Sindh, NWFP and Balochistan.

"Thus despite the use of storage administrative measures, the Punjab government failed to meet its procurement target," the bank regretted adding that the objectives of stabilizing price of wheat in Punjab could have been easily achieved by timely announcement of the government's intentions to import wheat to bridge the gap between consumption and domestic production of the commodity. Following the failure of the administrative measures, the government has announced that it will import one million tons of wheat.