KARACHI: The State Bank of Pakistan increased on Wednesday the interest rate by 50 basis points to 10 per cent because of high inflation and rising fiscal deficit.
The new rate will be effective from Nov 18 for two months.
The SBP said in its bi-monthly monetary policy that the CPI inflation was likely to remain at the high level of 10.5 to 11.5 per cent, adding that an increase in inflation with the interest rate remaining at the current level could add to the incentive for borrowings and discourage savings.
“This can potentially increase demand pressure through consumption and dampen investment and thus the productive capacity of the economy.”
The SBP ignored a suggestion by some economists that a further increase in the interest rate would keep the private sector out of banking money which would eventually suppress economic growth.
The central bank believes that “fundamentals of the economy are going forward against the backdrop of the recent monetary policy and reform measures appear stable”.
It said there were indications of a pick-up in economic activities. The growth in large-scale manufacturing was 8.4pc during the first quarter of financial year 2013-14. Similarly, exports marginally picked up, growing at 1.3pc.
“Notwithstanding rising inflation, the prospects of an economic revival inspired by successful political transition and resolution of energy-related circular debt issue are encouraging,” the SBP said.
It estimated that fiscal deficit for the current fiscal year would be slightly higher than the budgeted target of 6.3 per cent. The decline in the estimated fiscal deficit, from 8pc in the last fiscal year, owes much to the realisation of non-tax revenues such as the Coalition Support Fund.
The first instalment of CSF ($322 million) was realised in October and the remaining is expected during the current and forthcoming quarters.
“Similarly, the realisation of other proceeds is also critical to maintain the deficit within the estimated level,” the bank said, adding: “What is more important to consider is the fact that these are either one-off receipts or may not be relied upon on a long-term basis. A more permanent solution still lies in tax reforms.”
Justifying the increase in the interest rate, the SBP said the negative real return could encourage outflow of foreign exchange increasing the pressure on exchange rate. The deterioration in external accounts continued in the current financial year, largely on account of weak financial inflows.
The speculative sentiments on account of end-Sept targets set by the International Monetary Fund resulted in exchange rate volatility. “Such sentiments are an attribute of uncertainty over foreign exchange flows,” the SBP said, adding that the successful completion of structural benchmarks under the IMF programme would also ensure additional financial inflows from other international finance institutions.
In the absence of such reforms, it said, the burden of adjustment fell disproportionately higher on interest and exchange rates which might perpetuate speculative sentiments in the market.
“The revision in power tariff is expected to contribute in curtailing subsidies and thus creating fiscal space for other expenditures. Such fiscal consolidation measures, however, have their inflationary consequences also,” the bank said.
It said adjustments in administered prices were directly reflected in higher inflation and raised inflationary expectations, as is evident from the current trend in CPI inflation. “After witnessing a significant decline in FY13 (last fiscal year), inflationary pressures are resurging and could be observed in the sharp increase in inflation during the first four months of FY14. This trend is being contributed by both food and non-food groups. However, the reversal in food inflation is relatively sharp,” the SBP said.