KARACHI, April 19: The State Bank of Pakistan (SBP) on Wednesday said it would maintain a tight monetary policy on account of the unstable downtrend in inflation which continued to pose a serious challenge to macroeconomic stability.

“The SBP believes that inflation is projected to fall in the range of 7.7 to 8.3 per cent during FY06. The (recent)downtrend in inflation may prove unstable and could pose a challenge to macroscopic stability,” the State Bank said in its second quarterly report for the year 2005-06.

“There is an urgent need for the government to supplement its supply-side measures with policies to address market structure problems,” it said.

The State Bank also revised the rate of monetary growth from 12.8 per cent to 14.3 per cent and inflation in the range of 7.7 per cent to 8.3 per cent.

The report expressed serious concern over the widening of current account deficit on the basis that it initiates a vicious circle of debt creation, exchange rate depreciation and inflation.

The State Bank held the government responsible for monetary expansion and said that Rs178.2 billion for budgetary borrowing during July-Feb, 2006, was an important factor in the high monetary growth.

“Borrowing from domestic sources other than the SBP simply results in a shift of demand from the private sector to the government. The SBP has suggested issuance of long-term Pakistan Investment Bonds to lower dependence on SBP borrowings.

The report said that the current account deficit is expected to swell to 4.7 per cent of GDP by end-FY06. “In the longer run, large current account deficits cannot be sustained, as these would initiate a vicious circle of debt creation, exchange rate|depreciation and inflation,” warns the SBP.

The SBP said substantial policy revisions and sustained reforms were needed to meet the challenges of increasing both investment and savings.

“In the years ahead the country will be increasingly constrained in its ability to meet the growing consumption and investment needs without generating inflationary pressure and an accelerated growth in the country’s debt stock,” said the SBP report.

SBP forecasts that the GDP growth will fall in the range of 6.3 per cent to 6.8 per cent during FY06.

The report also stressed the need for further tax effort to raise the tax-GDP ratio substantially over the next few years. In this context, the reported plan of the CBR to seek a one percentage point increase in the tax-GDP ratio in the next five years needs to be vigorously implemented.