KARACHI, April 13: The State Bank on Wednesday made the biggest ever increase in treasury bills yields to contain inflation that reached a seven-year high in nine months of this fiscal year. But since the central bank has acted too late — and since interest rates are gradually becoming ineffective in containing an unprecedented rise in the private sector credit —- one should not expect any substantial relief in inflation.

“Inflation still looks set to settle between nine and 10 per cent during this fiscal year,” says Dr Javed Akbar Ansari, Dean, College of Management Sciences of the PAF Karachi Institute of Economics and Technology.

Dr Ansari says tackling high inflation through tightening of interest rates is becoming too difficult as additional private sector borrowing is not being used for financing production. Much of it is finding its way into speculative areas of activities, including stock market and real estate.

On Wednesday, the State Bank increased the cut-off yield on three-month and one-year treasury bills to 6.39 and 7.25 per cent, from 5.01 and 5.95 per cent, respectively. This huge increase of 130 basis points and 138 basis points, respectively, in the maximum yield on three-month and one-year bills shows the central bank has realized that the earlier modest increases were insufficient to check inflation.

Inflation during July-March 2004-05 increased at the rate of 9.06 per cent whereas in March 2005 alone it went up by 10.25 per cent. In the last six years, the pace of increase in inflation had never been that high.

That the central bank had to sell more than the targeted amount of T-bills in Wednesday auction to increase their yields sharply, it reinforces the view that from now onwards it would tighten interest rates more aggressively than in the past. The SBP sold Rs100 billion worth of these bills against the initial target of Rs70 billion.

What prompted the central bank to make a huge increase in treasury bills yields is that it is not only overall inflation that has been on the rise, but core inflation or inflation responsive to changes in the monetary policy has also been rising steadily.

Core inflation or non-food, non-fuel inflation, went up by 7.29 per cent during July-March 2004-05. This pace of increase in core inflation means there is room for further tightening of interest rates -— and that is exactly what the SBP is now doing. The tightening of interest rates is expected to check an unprecedented growth in the private sector credit offtake which, in turn, would bring down inflation.

The private sector credit expanded by Rs348 billion in little less than nine months of this fiscal year -— just short of the revised full fiscal year target of Rs350 billion and far higher than the actual annual target of Rs200 billion.

In its fight against inflation, the central bank also increased its discount rate on April 11 by one-and-a-half percentage point to nine per cent after more than two years.

The increase in discount rate coupled with faster-than-ever increases in treasury bills rates is aimed at containing growth in the private sector credit and thus check inflation.

But whether interest rate tightening can really dampen inflationary expectations is debatable.

“What we need now is a sea change in macroeconomic framework not just tightening of monetary policy,” says Dr Ansari.