KARACHI, Jan 19: The State Bank says that four things may continue to fuel inflation in the second half of this fiscal year adding that inflation may reach near 7 per cent at the year-end in June.
Things that can fuel inflation further include increase in credit disbursement by the banks, increase in oil prices, higher trade deficit and rising real asset prices. The central bank says it would, therefore, "continue to tighten the monetary policy by increasing interest rates (in January-June 2005)." But in doing so it "would maintain a healthy balance between suppressing inflation and facilitating investment, growth and employment in a non-inflationary environment."
The SBP made this observation in its monetary policy statement for the second half of this fiscal year issued here on Wednesday afternoon. Earlier, the SBP board of directors approved the policy statement at a meeting held at the SBP head office and presided over by Governor Dr Ishrat Husain.
"The State Bank would remain alert to the movements in key monetary and credit variables and take corrective measures if required to ensure price stability," added the statement.
Even before announcing its policy statement, the central bank had increased the yields on three-month and one-year treasury bills to reinforce its earlier signals that it would keep tightening the monetary policy to fight inflation.
The central bank increased the weighted average yield on three-month and one-year bills by 22 basis points and 52 basis points respectively to 4.14pc and 4.95pc at a regular auction of the bills held on Wednesday.
During the first half of this fiscal year (July-December 2004), the SBP had increased the weighted average yield on three-month and one-year bills by 222bps and 224bps respectively.
During this period it had also raised the average yield on six-month bills by 166bps to 3.73pc. Earlier this month, the central bank raised the average yield on six month further by 43bps to 4.16pc. All this tightening of interest rates was aimed at curbing inflation.
This, together with other fiscal and administrative measures taken for the same purpose, brought down year-on-year inflation from 9.26pc for July 2004 to 8.81pc for July-December 2004.
"The core inflation, on the other hand, is still heading upwards, though at a slow pace and has risen to 6.8pc in December 2004 from 6.1pc in July 2004," reveals the SBP policy statement.
But it says that the rising trend of interest rates is likely to arrest the current rise in price pressures. In addition, it identifies six factors that may also weaken inflationary pressures and expectations during January-June 2005.
These include robust growth in agriculture and industry; improved food supplies from additional wheat import; improved fiscal performance reinforced by sustained improvement in financial performance of public sector enterprises or PSEs; expectation of stable exchange rates with SBP's commitment to provide foreign exchange for imports; potential addition to exportable surplus resulting from record-high cotton production; and weak wage pressures in the labour market due to high unemployment.
After giving an overall review of the economy during the first half of this fiscal year, the SBP policy statement says that the economy "is expected to remain on track with sustained growth and recovery."
"The on-going credit boom is projected to contribute more to the GDP growth than to the consumer price inflation," it says referring to a record high disbursement of Rs244 billion credit to the private sector between July 1 and December 25, 2004. (The figure shot up further to Rs285 billion as on January 1, 2005, far exceeding the target of Rs200 billion set for the full fiscal year).
Commenting on the private sector credit expansion, the SBP policy statement says that between July 1 and December 25, 2004, Rs127.5 billion or 52.2pc of the total private sector credit off-take went to the manufacturing sector.
Consumer financing accounted for the second largest share of Rs39 billion or 15.9pc, followed by commerce that took up Rs27.8 billion or 11.4pc and services sector that borrowed Rs20.3 billion or 8.3pc of the total private sector credit.
Transport, storage & communication sector's borrowings totalled Rs12.6 billion or 5.2pc and that of agriculture at Rs8.7 billion or 3.6pc. The borrowings of the textile sector, the mainstay of the domestic industrial activities, increased by 25.4pc to Rs95.4 billion or 75pc of the total credit utilized by the manufacturing sector.
Within consumer financing, most of the consumer loans were availed for acquisition of automobiles (Rs22.1bn) followed by housing finance (Rs8.6bn) and credit cards (Rs3.5bn).
Commenting on the government's borrowing from the banking system, the SBP policy statement says that between July 1 and December 25, 2004, it increased by Rs34.8 billion against the full fiscal year target of Rs45 billion. "This was mainly due to the shortfall in non-bank borrowings budgeted for FY05, and high foreign payments."
"In addition, the government also bore the brunt of oil price hikes by not passing them fully to the consumers," the statement says referring to the capping of domestic oil prices during May-November 2004. (The government started passing on the impact of increase in international oil prices on domestic prices from December 2004).
"On the basis of expected receipts and expenditures during the next six months, it is expected that the government's budgetary borrowings from the banking system would remain within the annual target."
Commenting on inflation and interest rates, the statement says that although interest rates are rising, they are still low and negative in real terms at their current levels.
The statement cites it as a reason for record high private sector credit off-take that averaged at Rs40.7 billion per month in the first half of this fiscal year (based on the credit data for July 1-December 25, 2004).
"In view of recent monetary and credit trends plus the inflation outlook, interest rates are expected to continue to rise until inflationary pressures are significantly eased off," the statement says. But it hastens to add that the central bank "would ensure through the conduct of the monetary policy that the adjustments in (interest) rates do not retard the process of economic growth."