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KARACHI, July 21: The State Bank said on Wednesday it would go for a measured tightening of its monetary policy during July- December 2004 to contain inflation. But in doing so it would ensure that the current growth and investment momentum is not impaired.
SBP said this in its monetary policy statement for the first half of this fiscal year. The central bank issued the statement after its board of directors had approved it at a meeting in Lahore. The statement is a public announcement of the monetary policy stance the SBP would follow during July-December 2004.
The statement says that domestic prices may continue to increase and exchange rate may be under pressure in July-December 2004. "The lingering overhang from the last two years' monetary expansion has to be wrung out of the system thus lowering the inflation risk premium built into market expectations," it said.
"Therefore, the State Bank will continue to exercise vigilance on the movement of key variables and make a smooth transition from an expansionary monetary policy stance to measured tightening to avert inflationary pressures and maintain stability in exchange rate."
"This measured response will have to ensure that the current growth and investment momentum in the country is not impaired in any significant manner, export competitiveness is maintained while inflation is kept under control," the statement further said.
It said that raising interest rates rapidly or aggressively when the economic recovery is still incipient, a significant slack exists and unemployment rates are rising, "will entail real economic costs." Hence the SBP decision for a gradual switch-over from expansionary to a tight monetary policy.
"The State Bank remains firmly committed to price stability and will use both the tools of monetary policy as well as prudential regulations to achieve this goal," the statement added.
The statement spread over 12 pages also made comments on the developments in the last fiscal year and on macroeconomic outlook for this year. "Pakistan economy is...better placed in terms of achievement of medium-term growth targets in view of the momentum already gained in the last fiscal year and existing global trends that augur well for the world economy, at least in the short term," says the statement.
Discussing key macroeconomic targets for this fiscal year including 6.6 per cent GDP growth with 5 per cent consumer inflation the statement said that to achieve these targets the broad money would be allowed to expand by 11.4 per cent.
"Consistent with higher growth and development, the main thrust of monetary and credit policy would be to ensure adequate availability of bank credit to private sector while containing inflation."
The statement further said that the constellation of risks has changed in a perceptible manner since the issuance of last monetary policy statement in January this year. On the negative side:
* International interest rates have begun to edge up and there is fairly strong expectation that these rates will move upwards in the coming quarters. Therefore, the differential between Pakistan rupee interest rates and US dollar, Euro, Yen and Pound Sterling interest rates should not be allowed to widen.
*Strong import demand witnessed in FY04 is unlikely to be depressed in the current fiscal year worsening the trade balance and therefore exerting a downward pressure on the exchange rate.
* Hike in asset prices, adjustment in wages and salaries awarded to public servants will also put upward pressure on prices.
On the positive side:
* Fiscal deficit is likely to remain at 4 per ent of GDP and along with the improved financial balances of public sector enterprises the demand from the public sector, barring any unforeseen events, would not pose any serious concern.
* Lower capital inflows would moderate the monetary and reserve money growth.
* Lower world prices of raw cotton should help the textile and clothing sector in its export drive but much depends on how fast the textile export industry is able to expand its share in the post-MFA textile markets of North America and Europe.
* The continued growth of textile sector should take place with lower demand for working capital from banking system thus easing somewhat the pressure on private sector credit.
* Imports of wheat of one million tons should facilitate the government to stabilize the prices of wheat flour during the lean months effectively but the uncertainty about oil and commodity prices remains worrisome.
* The state of labour market shows high degree of unemployment in the country with very low pressure for wage rise outside the public sector. An inappropriate or more aggressive monetary policy will only aggravate the unemployment problem.
INFLATION: The SBP monetary policy statement says that consumer inflation is expected to behave normally during this fiscal year in view of rising interest rates, fast stabilizing food prices, relatively stable exchange rates and modest inflationary expectations.
INTEREST RATES: The statement says that the present rising trend of interest rates is expected to continue for some time to come. The SBP prediction is based on decelerating foreign capital flows, modest inflationary expectations, significant credit provision for the private sector during this fiscal year and also rising interest rates in the international financial markets.
"However, SBP will be quite vigilant and will make sure that the process of interest rates hikes is gradual and that it does not adversely impact the ongoing growth momentum essential to achieve 6.6 per cent growth."
ECONOMIC PROSPECT: In summary, Pakistan's economy is poised to do well during the current fiscal year in view of on-going growth momentum generated by all time high credit offtake of Rs301 billion by the private sector in the last fiscal year.
"Interest rates are projected to rise gradually in response to liquidity constraints, rising interest rates in the international markets and inflationary expectations but their potential adverse impact on investment and growth will be minimized through better monetary and exchange rate management.
