April 19, 2008	Saturday	Rabi-us-Sani 12, 1429

SINGAPORE, April 18: The State Bank of Pakistan risks losing credibility unless it acts fast to rein in soaring inflation and the authority should not wait until July, when its next regular policy review is due.Pakistan’s economy is facing the same problems as its neighbours: rising prices of imported food and fuel, a threat to exports and growth from slowing developed markets and a deterioration in the trade balance.

In addition, the central bank has to accommodate a spendthrift government.

Higher policy rates would help in several ways. The rupee’s decline could slow and higher yields would rein in consumer spending and make it more expensive for the government to borrow from the market.

The political upheaval of the past year has scared foreign investors and slowed foreign capital inflows at the same time that the new government’s unbridled borrowing and spending has pumped cash into the economy and exacerbated price pressures.

Raising rates would push up borrowing costs and swell the government’s huge debt burden, besides causing growth to skid.

But higher borrowing costs could also have an effect of forcing the government to cut back spending.

The central bank raised rates at its two previous meetings, in January 2008 and July 2007. But economists say monetary conditions need to be tightened more, and rates ought to be raised even before the next scheduled policy review in July.

“Regardless of the fiscal constraint, they have to signal that they want to take inflation head-on,” said Sanjay Mathur, chief emerging Asia economist at Royal Bank of Scotland.

The central bank could either keep intervening to ensure the falling rupee stabilises or raise policy rates aggressively, he said.

“If it disturbs the fiscal position, then that should be the basis for the government to actually start cutting expenditure in areas where they can cut,” Mr Mathur said.

Consumer prices in March were 14.12 per cent higher than a year ago, pushing inflation to its highest level in 13 years and spelling trouble for an economy that has notched up average growth of 7 per cent a year since 2002.

At the same time, rising import costs have widened the trade deficit, pressuring the rupee, with economists forecasting it will hit nearly 10 per cent of economic output this year. The rupee hit a 6-1/2-year low this week.

Meanwhile, the government’s financing needs have ballooned, a large chunk spent on consumer subsidies on fuel and food.

Rising inflation has limited the scope to raise subsidised prices to lower the subsidies bill.

Finance Minister Ishaq Dar said last week that the fiscal deficit had risen to 4.7 per cent of the GDP in the first eight months of the fiscal year, and could exceed 9 per cent if nothing is done.

Economists worry that the central bank is printing too much money to finance the government’s lavish spending, a factor that has kept money supply growth in the high teens.

“We are indeed concerned about the large amount of liquidity in the banking system that can fuel further asset and consumer price inflation,” Deutsche Bank economist Taimur Baig said in a note.

The policy rate, at 10.5 per cent, is the second highest in

Asia. Yet, inflation-adjusted real interest rates are negative, meaning consumers are tempted to spend rather than save their money.

Economists say domestic demand is a big reason why inflation has hit double digits despite controlled wheat and petrol prices.

For instance, house rents, the second biggest component of the consumer price index, rose 10.60 per cent in March from a year earlier.

SBP Governor Dr Shamshad Akhtar has earned the admiration of market players, for steering markets through the emergency rule, the assassination of former prime minister Benazir Bhutto in December and elections this year.

The rupee has only lost 5 per cent against the dollar in the past 12 months of turmoil, and the stock market rose 28 per cent.

But now, investors expect some tough and fast action from the central bank.

There is talk Pakistan’s already sub-investment grade ratings may be cut further and that the South Asian economy may be forced to ask the International Monetary Fund for money.

This week, China agreed to give Pakistan a $500 million loan to meet its funding needs.

“Given what has happened on the political front, the economy, the exchange rate and financial assets have outperformed the politics,” said ING’s chief economist for Asia, Tim Condon.

“But now inflation is at a level in Pakistan where the jump to hyper-inflation is easy. The central bank needs to persuade people that they are on the case.”—Reuters