KARACHI, Jan 12: The State Bank of Pakistan on Monday reported the core inflation was above 18 per cent which could be a bad sign for the economy as the further increase in policy discount rate was attached with the lowering of core inflation.

According to an SBP report the core inflation (non-food non-energy) at the end of December 2008 was 18.8 per cent which was higher than the expectation of the government.

Adviser to Prime Minister on Finance Shaukat Tarin had announced in November at the formal announcement of the agreement with the International Monetary Fund (IMF) that the policy discount rate might go up if the core inflation did not come down.

The policy discount rate was increased by two per cent to 15 per cent as part of the agreement with the IMF. The government negotiated a total increase of 3.5 per cent in the discount rate before signing the deal of $7.6 billion of which $3.1 billion had already received by the country.

The core inflation in November was 18.9 per cent, which was much higher for any economy, and the adviser had said that the policy interest rate would be increased by 1.5 per cent if it remained high.

The State Bank is expected to announce its monetary policy by end of this month. The 15 per cent policy discount rate has been translated into lending rates above 20 per cent by the commercial banks which attracted wide criticism by business circle including the banks themselves.

“The government is bound to increase the interest rate as per the IMF agreement, but the economy could not absorb any further hike,” said Mohammad Imran, head of research at a local brokerage house.

Traders and industrialists have been demanding a major cut in the policy discount rate. They said the high lending rates make them unable to remain cost-effective.

While no assurance was given to the business community for cut in the discount rate, the banks also found it counterproductive as the real credit outflow has been shrinking.

Banks have shown a growth of 7 per cent in advances in 2008 but the bulk of credit went to pay the dues of Oil Marketing Companies (OMCs).

The JS Securities reported that gross advances of banks was up by 18 per cent in 2008 but the higher provisioning and the payment by OMCs made it much lower than previous growth.

The gross advances of scheduled banks reached Rs3.1 trillion as of Dec 27, 2008 but after adjusting these advances against provisions of Rs212 billion, net advances of the industry arrived at Rs2.9 trillion. The high provisioning is another negative impact of high interest rate as the growth of non-performing loans (NPLs) is damaging for the banking industry.

“The government borrowings from commercial banks to pay outstanding Price Differential Claims to OMC’s and other energy sector companies were major contributors to the robust advances growth,” said the JS report, adding that this was still lower than previous five-year (2003-07) average annual growth of 22 per cent.

“There was no change in real advances growth, as credit penetration remained at 30 per cent of GDP, similar to levels at end Dec 2007,” said the report.

Bankers said further increase in the discount rate would only add more pressure on the banking industry as well as the economy. They said the higher interest rate would damage both the economy and the banking industry.