KARACHI, May 22: The State Bank has increased the benchmark interest rate by 1.5 per cent to 12 per cent in an attempt to curtail the rising inflation which has caused huge deficits and high unemployment.

At a hurriedly-called press conference on Thursday, SBP Governor Dr Shamshad Akhtar also announced five major steps to bring correction to the economy.

She admitted that she had been unable to stop the government from inflating the economy by borrowing from the SBP which was the main reason of economic instability.

“This rate increase has been necessitated by the persistent and excessive government borrowing from the SBP,” Dr Akhtar said.

She proposed for limited government borrowing from the next fiscal which had already reached Rs544 billion up to May 19 from July 1, 2007. If the stock of treasury bills is included, it will reach about Rs950 billion, which is 9.4 per cent of the GDP.

Interestingly, this huge debt, equally 9.4 per cent of GDP, is not shown in the total domestic debt. The governor proposed that expected foreign exchange inflows should be used to retire the SBP debt.

In FY08, it is estimated that the government had till now financed around 80 per cent of its fiscal deficit from SBP borrowings, she added.

At present the government has kept borrowing from the central bank outside the legislation which has eroded the fiscal discipline and diluted the impact of the Fiscal Responsibility Act. Most central banks in the world did not allow governments to borrow from them, Dr Akhtar said.

The governor said the real interest rate was less than two per cent which demanded an increase. She said the higher interest rate would not impact upon the borrowing of the private sector.

The private sector borrowing, she said, was much higher than last year mainly because the real interest rate was just two per cent.

The real interest rate will remain around three per cent after the 1.5 per cent hike.

However, the negative impact of the decision will be felt immediately in the capital market and banks and industrial, manufacturing and trading sectors will oppose the decision as they did in February this year when the discount rate was increased by 0.5 per cent.

Banks see less advances while manufacturers and traders see higher cost of production and services.

An economist said the higher interest rate would reduce credit flow towards the private sector; less credit would slow down the economic activity; low economic growth would mean less revenue and more borrowing from multilateral agencies.

The SBP governor said that effective June 1, 2008, all banks would be required to pay a minimum profit of five per cent on savings or PLS saving products.

The saving deposits category accounts for more than 43 per cent of all bank deposits and constitutes 63 per cent of the total number of countrywide deposit accounts. At present the average return on all saving accounts is 2.1 per cent.

The SBP increased the Cash Reserve Requirement (CRR) for all deposits up to one year maturity by 100bps to 9.0 per cent while keeping the CRR for deposits of over one-year maturity unchanged at zero per cent. In addition, the Statutory Liquidity Requirement (SLR) was increased by 100bps to 19 per cent of the total time and demand liabilities.

“Effective May 23, the L/C margin on all imports, except for oil and selective food imports, is being imposed at 35 per cent,” the governor said.