KARACHI, Dec 2: The State Bank of Pakistan apprehends inflation rate in the current fiscal year “may remain above 6.5 per cent annual target” because of the government’s inability to reduce petroleum prices.

The bank also identifies risks of possible increase in house rent index (HRI), a rise in food cost and a jump in domestic wheat price despite a bumper crop “if speculators try to take advantage of rising international prices”.

“An excessive rise due to speculative activities can lead to a net welfare loss to the economy,” warns the SBP annual report for the year 2005-06, which was released here on Saturday at a press conference by SBP Governor Dr Shamshad Akhtar.

The report advises the government to defer the exports of wheat, until the size of the crop is known and until buffer stocks are in place. The central bank’s prescription to counter speculators is to ensure sufficient quantity of stocks with the official agencies.

“While inflation was principally driven by non-food component during FY06, the inflationary pressures in FY07 are likely to stem from both food and non-food components,” observes the report while justifying the continuation State Bank’s tight monetary policy in the current fiscal year also.

But the central bank is mindful of inherent dangers of excessive tight monetary policy on the growth and therefore it wants the government to take adequate administrative measures on supply side to ensure price stability.

Coupled with risk of above than officially targeted inflation of 6.5 per cent in the current fiscal year is the fear of a widening external current account deficit largely due to extra ordinary rise in trade imbalance which the State Banks says is obviously a starting point for corrective policy, with options revolving around a mix of reducing import growth and fostering strong export growth.

The bank implies difficult choice if large external imbalances persist while weighing the pros and cons of the options available to tackle the situation. The report offers two options that are a raise in interest rates to curb demand and encourage depreciation in the rupee to boost exports.

“Both of measures would, in the medium-term, help exports by either reducing inflation by holding down the cost of producing goods, or reducing the cost of local goods for foreign buyers,” it argues but points out that “both have a significant costs”.

“On the one hand, given the prevailing tight monetary policy, a further sharp rise in interest rates could risk considerably slowing the growth momentum of the economy, and on the other hand, a sharp depreciation in the rupee value could lead to self fulfilling expectations that could destabilise the economy,” the report says.

A somewhat consolation factor is SBP’s projection of slowing down of import pace in FY07 than FY06 because of fall in international oil prices and a sharp decline in machinery import. “Unfortunately, the SBP forecast also indicates that this may not be enough to substantially reduce the trade deficit in FY07 as it foresees a slowdown in exports also,” the report predicts.

The report’s prediction of lower export growth is based on the trends evident in recent months that show that the increasingly competitive exports market has taken a toll in terms of lower prices as well as a fall in volumes of some products. While pleading for a support to the exporters the SBP rules out the provision of direct subsidies as it carries a significant cost in the long-run and instead suggest measures to reduce cost of doing business, improvement of infrastructure, enhance labour skill, strengthening managerial capacity, reducing unit labour costs and more importantly a reliable supply of energy at competitive prices.

“Energy shortages may become acute in the near future,” is another warning of the SBP report while referring to the initiatives taken by the government in short- and long-term perspectives. “In short-term, offering a clear policy with one window implementation appears an urgent necessity,” the SBP report stresses.

The SBP’s prescription to tackle energy issue is to develop a mix of diversify and reliable sources that are hydel, nuclear, Pak-Iran gas pipeline and coal reserves.

In this utter dismal economic scenario emerging in the FY07, the SBP is confident of a 7-per cent growth in the economy. It foresees a recovery in agriculture and manufacturing sector.