KARACHI, Jan 18: The SBP has warned that high food prices have the potential to neutralise all efforts being made to control the spiralling inflation which rose to 8.9 per cent in December and will exceed the target for the current year.
“The continuing high food inflation is the key driver for pressure on the overall CPI (main inflation); and has a potential to dilute the impact of monetary tightening by strengthening inflationary expectations in the economy,” said the monetary policy announced by State Bank Governor Dr Shamshad Akhtar at a press conference on Thursday.
“Inflation outcome for the financial year 2006-07 is likely to be higher than the annual target for the year,” said the policy report.
In the wake of threatening inflation, the SBP decided to continue with the existing tight monetary policy for the next six months; however, it further raised the daily cash reserves requirement which is a move to keep strong hold over the liquidity.
The governor said that the SBP was facing the same challenges it had to tackle last year regarding the inflationary pressure except lowering of oil prices.In the last monetary policy `for July-December 2006’ the discount rate was increased by 0.5 per cent to 9.5 which resulted in high interest rate and slowdown in credit off-take by the private sector.
“The SBP will continue to pursue its existing tight monetary policy stance during the remaining half of FY07,” said the report.
The SBP realised that the focus on reducing domestic inflation was also required to help contain the cost of doing business in Pakistan, which was essential for improving the country’s external competitive position.
The slow export growth during July-Nov 2007 was extremely worrisome for the SBP as it said the trade gap had worsened and it happened despite the high subsidised credit off-take by exporters.
The SBP has allowed liberal access to concessional Long-Term Financing for Export-Oriented Projects (LTF-EOP) and has lowered the financing cost of eligible items under the Export Finance Scheme (EFS). In fact, real lending rates on EFS and LTF-EOP are negative and even lower than the rates prevailing in regional countries.
This subsidised money is also causing inflation and posing difficulties for the SBP to manage the liquidity. This money contributed in reserves money which causes monetary expansion.
“Reserve money increased by 19.0 per cent during H1-FY07 compared to the 8.4 per cent growth recorded in the corresponding period last year,” said the SBP.
An additional risk to growth in reserve money emanates from the expected large foreign exchange inflows during H2-FY07 mainly from privatisation proceeds and planned inflows on account of GDR flotation.
The SBP further says that foreign exchange flows are also causing inflationary impact as these inflows translate into huge liquidity.
“Large foreign exchange inflows would also imply that monetary policy has to be necessarily kept tight in order to mitigate the risks of excessive expansion in the domestic liquidity.”
The expansionary fiscal policy has been another tool for inflating the economy. The SBP held the government’s increasing reliance on the central bank for its borrowings, responsible for creating difficulties to manage the monetary affairs.
“The pattern of government borrowings and its increasing reliance on the central bank are major sources of concern,” said the SBP policy report.
The inflation in Pakistan is relatively high compared to its competitors and trading partners.
In fact, this higher domestic inflation has offset the gains emanating from nominal depreciation and the real exchange rate, measured in terms of the real effective exchange rate (REER) index, appreciated slightly by 1.0 per cent during H1-FY07, said the SBP.
“In sum, while most of the risks and challenges identified in the monetary policy statement for H1-FY07 still persist (except for the threat of continued acceleration in international oil prices),” said the SBP.
