KARACHI, July 29: The State Bank has increased the benchmark interest rate by 100 basis points to 13 per cent in a bid to contain inflation and trade and budget deficits.

State Bank Governor Dr Shamshad Akhtar unveiled at a press conference on Tuesday the monetary policy for the first half of the current fiscal year, 2008-09.

Except for increasing the discount or policy rate, the SBP made no changes in the already tight monetary policy.

“Considering the risk related to rising external current account and fiscal deficits and worsening inflation outlook, the central bank has decided to raise its policy rate by 100 basis points to 13 per cent effective July 30, 2008,” said Dr Akhtar.

The central bank also decided to compel the government to retire the debt it accumulated through aggressive borrowing, which reached Rs689 billion on June 30.

“Considering the adverse impact of continued borrowing by the government from SBP on inflation, the SBP central board of directors resolved that the government should retire Rs21 billion in each quarter of FY09,” she said.

According to the State Bank, the government had borrowed Rs32.9 billion from the SBP during the first 25 days of the current fiscal year. “This pattern is not in line with SBP’s recommendation.”

Stressing the need for macroeconomic stability, the SBP governor also warned the government to curb its heavy reliance on borrowing from the central bank.

According to SBP figures, the government had borrowed Rs149.8 billion between May 25 and June 30. Budget estimates for 2008-09 put government borrowing at 7 per cent of GDP, while financing data compiled by the SBP for the full FY08 showed that it would be about 8.3 per cent.

Expressing doubts about reliability of government’s spending and revenue projections in the budget, she said: “Aside from the changing oil and exchange rate scenario relative to budgetary assumptions, SBP assessment is that budget underestimates spending and overestimates revenues.”

She said that containing expenditure growth at 6.5 per cent, “given a track record of 20.3 per cent average increase during the past five years, seems difficult and the subsidy bill is likely to come under strain unless political pressures are muted”.

“Similarly, realising the estimated growth in tax revenue at 24 per cent also seems high given the average growth of only 12.8 per cent during the past five years.”

She said early indications were that the budget deficit target for FY09 of 4.7 per cent of GDP was “already … under stress”.

Dr Akhtar stressed that the overly optimistic assumptions carried the risk of fiscal slippages beyond target again.

“Even a one percentage point increase in fiscal deficit above the target level would require additional borrowings in the order of over Rs100 billion,” she added.

“What is worrisome is that there are severe external and domestic constraints which make it difficult for raising the required financing on a timely basis for the projected fiscal deficit for FY09.”

She said that generating the “same amount domestically from sources other than the central bank would result in crowding out of credit availability to the private sector”.

Calling for a consistent and coherent macroeconomic framework, she said imposing hard budgetary constraints required the government to amend the ‘Fiscal Responsibility and Debt Limitation Act of 2005’ to include provisions for phasing out government’s dependence on SBP borrowings over a certain period.

“This involves adherence to limits imposed on SBP borrowings henceforth, while lowering the stock of SBP borrowings.”

Terming inflationary pressures in the economy alarming, Dr Akhtar said on average basis, headline CPI inflation, at 12 per cent in FY08, was “5.5 percentage points above the annual target and underlying this, non-food inflation more than doubled to 13.8 per cent since December 2007”.

In June 2008, the year-on-year headline CPI inflation reached the 30-year high of 21.5 per cent, while food inflation rose to a record high of 32 per cent.

Criticising the widening external account deficit, she said that despite record flow of worker’s remittances and buoyant exports, the external current account deficit grew to $14 billion, equivalent to 8.4 per cent of GDP – which was around three and a half percentage points higher than the initial projections for FY08 and more than twice the past year’s level in absolute terms.