SBP discount rate unchanged at 10 percent
KARACHI: State Bank of Pakistan (SBP) has decided to keep the policy rate unchanged at 10 percent, Media reported.
It was announced by SBP Governor, Yaseen Anwar, while unveiling the Monetary Policy Statement (MPS) at a press conference here on Friday afternoon.
The decision was taken at a meeting of the Central Board of Directors of SBP held under chairmanship of the governor earlier on Friday.
According to the policy statement, the SBP increased the policy rate by 50 basis points (bps) each in September and November 2013 mainly on account of two concerns. One was the continued deterioration in the balance of payments position while the other was worsening of inflation outlook.
Executive Summary
Nevertheless, due to earlier reductions in the policy rate and settlement of energy sector circular debt, credit to private businesses and economic activity has shown early signs of recovery.
Similarly, fiscal consolidation efforts have been initiated, which are expected to gradually alleviate pressure on monetary aggregates.
The fundamental weakness in the balance of payments position is persistent contraction in net financial flows since FY08. Substantial repayments of IMF loans during the last two and a half years have only increased the pressure.
For some time, SBP did manage to contain the repercussions of these developments. Nonetheless, due to continued net outflow of foreign currency from the system together with the need to build foreign exchange reserves, the exchange rate did experience substantial volatility during H1-FY14.
However, stress in the balance of payments could recede gradually. There is a marginal pick-up in net capital and financial flows of $800 million during July – November, FY14 compared to a decline of $263 million in the corresponding period of last fiscal year.
At the same time, considerable financial inflows are expected during H2-FY14.
These include overdue proceeds from the privatization of PTCL, floatation of euro bonds in the international market, and additional flows from bilateral and multilateral sources under the new IMF program.
Similarly, the payment of $1151.2 million to the IMF during Q2-FY14 was the peak of the loan repayment schedule. In fact, the net financing received from the IMF during H1-FY14 was negative $925.2 million despite receiving $1101 million under the new IMF program.
As payments decline during the coming quarters, net financing from the IMF will start to increase. The cumulative effect of these expected developments is going to be a gradual increase in SBP’s foreign exchange reserves, which have declined to $3.5 billion by 10th January 2014.
There is no room for complacency and considerable effort is required to bring a sustainable improvement in the outlook of external accounts. Specifically, two aspects of balance of payments require focus and reforms.
First, the net private direct and portfolio investments are far too low; 0.5 percent of GDP by end FY13. These will have to increase to reduce reliance on foreign loans and IMF programs and finance the external current account deficit.
Second, the export to GDP ratio, 10.5 percent by end-FY13, has been on a slight declining trend for over a decade now. Significant improvement in product and market diversification is required to reverse this trend and reduce the trade deficit.
The trade deficit has been hovering around 6.5 percent of GDP on average for the past five years. It is expected to increase to 7 percent of GDP or $17.1 billion in FY14 despite a projected increase of 6 percent in export receipts that includes the impact of recently approved GSP plus status accorded to Pakistani exports by European Union.
This is because import payments are also expected to grow around 8 percent due to pick up in domestic industrial activity.
Assuming a steady increase in workers’ remittances together with timely receipt of remaining Coalition Support Funds and proceeds from the auction of 3G licenses, the external current account deficit for FY14 is projected to remain in the range of 1.0 to 1.8 percent of GDP.
International commodity prices, especially those imported by Pakistan, have either remained stable or declined since the beginning of FY14. This has neutralized to some extent the direct impact of exchange rate volatility on CPI inflation.
Thus, the sharp increase in year-on-year CPI inflation during H1-FY14, from 5.9 percent in June 2013 to 9.2 percent in December 2013, is primarily due to domestic factors.
Specifically, to ease the stress on fiscal account due to substantial electricity tariff differential subsidy the government has increased the electricity tariffs in two stages during H1-FY14.
This has pushed up wholesale as well as consumer prices. Similarly, to check the declining tax revenues the government has increased the General Sales Tax (GST), withdrawn tax exemptions on some products, and increased income tax rates.
At the same time prices of perishable food items have increased considerably, except in December 2013 when they declined sharply, together with a rise in wheat prices.
Although the fiscal measures have adversely affected inflation outlook for FY14, they will help reduce budgetary borrowings from the banking system and thus inflationary pressures in the medium term.
Thus, the recent uptick in inflation is a cost of delayed fiscal adjustment. The important point is that the risk of demand-driven inflation is still rather moderate. For instance, the year-on-year Non Food Non
Energy (NFNE) inflation is 8.2 percent in December 2013; marginally up from 7.8 percent in June 2013.
This is because economic activity has remained quite sluggish over the past few years. It will take some time before expected pick-up in economic growth pushes up aggregate demand.
Nevertheless, SBP expects average CPI inflation for FY14 to fall between 10 to 11 percent, which would be higher than the target of 8 percent announced by the government.
Other than attending to external sector risks, the reason for recent increases in the policy rate was also to manage expectations in the wake of expected inflation remaining higher than the target and restrict decline in real interest rates.
In September 2013, the SBP also linked the minimum rate of return on average balances held in saving deposits with the floor of the interest rate corridor. Specifically, the return on saving deposits cannot be more than 50 bps lower than the floor of the interest rate corridor, which is currently 7.5 percent.
This policy intervention ensures that deposit rates respond more strongly to policy rate changes. This would help in deposit mobilization and maintaining a reasonable growth in deposits necessary to meet the credit requirements of the economy.
The credit availed by private sector businesses have responded to reductions in policy rate during the last two years and relative improvement in availability of electricity to productive sectors.
During the first five months of current fiscal year private businesses have borrowed Rs161 billion, of which Rs38 billion is for fixed investment, compared to Rs16 billion in the corresponding period of last year.
Substantial credit uptake by sectors such as textiles, electricity, gas, and water and commerce and trade has been observed. Improving financial position of major corporate sectors along with higher expected demand for their products and improvement in net NPLs to net loans ratio may help in sustaining this initial uptake going forward.
Due to its accelerated growth, the contribution of private sector credit in expansion of Net Domestic Assets (NDA) of the banking system has increased to 37.0 percent during 1st July – 27th December, FY14, which is considerably higher than 14.2 percent during the corresponding period of FY13.
However, fiscal borrowings for budgetary support continue to dominate overall monetary expansion for the same period. Moreover, unlike last year, all of these borrowings are from the SBP.
Specifically, in net terms, the fiscal authority borrowed Rs612.4 billion from the SBP and retired Rs18.5 billion to the scheduled banks.
This is because banks were not offering sufficient funds at market interest rates prevailing at the beginning of FY14.
Increases in policy rate in September and November 2013 have helped the fiscal authority in raising sufficient funds from the scheduled banks, albeit mostly in 3-month T-bills, and retiring some of their borrowings from the SBP in Q2-FY14.
This, together with declining foreign exchange reserves, has kept the market liquidity conditions tight and at times volatile. The result is that short-term market interest rates remain on the higher side compared to increases in the policy rate.
Nevertheless, the quarterly flow of fiscal borrowings from the SBP has remained positive in both quarters of H1-FY14. This does not bode well for the effectiveness of monetary policy.
The SBP expects that government will keep these borrowings in check in H2-FY14 and lower outstanding stock gradually as stipulated in the new IMF program. The growth in broad money (M2) based on the expected developments in various sectors of the economy is projected to remain between 13 and 14 percent.
Containment of fiscal borrowings from the SBP would increase borrowing requirements from the scheduled banks. Timely receipt of budgeted foreign inflows could provide some respite; however, consistent reduction in the size of the fiscal deficit is critical for medium term macroeconomic stability.
This would require significant tax, expenditure and debt management reforms. A persistently high fiscal deficit has already resulted in accumulation of short-term domestic debt at a very rapid pace; 27 percent on average during the last three fiscal years.
For FY14, the government has announced a fiscal deficit target of 6.3 percent of GDP and managed to contain it at 1.1 percent of GDP during Q1-FY14. This is a positive start that needs to continue not only during remaining months of this fiscal year but also in the medium term.
A key risk to the fiscal position is a possible shortfall in tax revenues, recurrence of energy sector circular debt, and delays in budgeted foreign inflows. Such deviations could lead to increase in borrowings from the banking system, further accumulation of domestic debt and higher-inflation.
Although there are some risks to the balance of payments position due to uncertainty surrounding expected foreign inflows, expected increase in inflation is slightly lower than anticipated earlier.
In view of the above, the Board of Directors of SBP has decided to keep the policy rate unchanged at 10.0 percent....
To a question the governor said the central bank enjoyed independence and free hand so far its Monetary Policy is concerned.
Replying to another question, he said the Currency Swap Agreement Line with China had proved very helpful to Pakistan. Originally it was for three years, Anwar said further.
Such an agreement with Turkey is in the pipeline and would be good for both the countries, he added.
It was announced by SBP Governor, Yaseen Anwar, while unveiling the Monetary Policy Statement (MPS) at a press conference here on Friday afternoon.
The decision was taken at a meeting of the Central Board of Directors of SBP held under chairmanship of the governor earlier on Friday.
According to the policy statement, the SBP increased the policy rate by 50 basis points (bps) each in September and November 2013 mainly on account of two concerns. One was the continued deterioration in the balance of payments position while the other was worsening of inflation outlook.
Executive Summary
Nevertheless, due to earlier reductions in the policy rate and settlement of energy sector circular debt, credit to private businesses and economic activity has shown early signs of recovery.
Similarly, fiscal consolidation efforts have been initiated, which are expected to gradually alleviate pressure on monetary aggregates.
The fundamental weakness in the balance of payments position is persistent contraction in net financial flows since FY08. Substantial repayments of IMF loans during the last two and a half years have only increased the pressure.
For some time, SBP did manage to contain the repercussions of these developments. Nonetheless, due to continued net outflow of foreign currency from the system together with the need to build foreign exchange reserves, the exchange rate did experience substantial volatility during H1-FY14.
However, stress in the balance of payments could recede gradually. There is a marginal pick-up in net capital and financial flows of $800 million during July – November, FY14 compared to a decline of $263 million in the corresponding period of last fiscal year.
At the same time, considerable financial inflows are expected during H2-FY14.
These include overdue proceeds from the privatization of PTCL, floatation of euro bonds in the international market, and additional flows from bilateral and multilateral sources under the new IMF program.
Similarly, the payment of $1151.2 million to the IMF during Q2-FY14 was the peak of the loan repayment schedule. In fact, the net financing received from the IMF during H1-FY14 was negative $925.2 million despite receiving $1101 million under the new IMF program.
As payments decline during the coming quarters, net financing from the IMF will start to increase. The cumulative effect of these expected developments is going to be a gradual increase in SBP’s foreign exchange reserves, which have declined to $3.5 billion by 10th January 2014.
There is no room for complacency and considerable effort is required to bring a sustainable improvement in the outlook of external accounts. Specifically, two aspects of balance of payments require focus and reforms.
First, the net private direct and portfolio investments are far too low; 0.5 percent of GDP by end FY13. These will have to increase to reduce reliance on foreign loans and IMF programs and finance the external current account deficit.
Second, the export to GDP ratio, 10.5 percent by end-FY13, has been on a slight declining trend for over a decade now. Significant improvement in product and market diversification is required to reverse this trend and reduce the trade deficit.
The trade deficit has been hovering around 6.5 percent of GDP on average for the past five years. It is expected to increase to 7 percent of GDP or $17.1 billion in FY14 despite a projected increase of 6 percent in export receipts that includes the impact of recently approved GSP plus status accorded to Pakistani exports by European Union.
This is because import payments are also expected to grow around 8 percent due to pick up in domestic industrial activity.
Assuming a steady increase in workers’ remittances together with timely receipt of remaining Coalition Support Funds and proceeds from the auction of 3G licenses, the external current account deficit for FY14 is projected to remain in the range of 1.0 to 1.8 percent of GDP.
International commodity prices, especially those imported by Pakistan, have either remained stable or declined since the beginning of FY14. This has neutralized to some extent the direct impact of exchange rate volatility on CPI inflation.
Thus, the sharp increase in year-on-year CPI inflation during H1-FY14, from 5.9 percent in June 2013 to 9.2 percent in December 2013, is primarily due to domestic factors.
Specifically, to ease the stress on fiscal account due to substantial electricity tariff differential subsidy the government has increased the electricity tariffs in two stages during H1-FY14.
This has pushed up wholesale as well as consumer prices. Similarly, to check the declining tax revenues the government has increased the General Sales Tax (GST), withdrawn tax exemptions on some products, and increased income tax rates.
At the same time prices of perishable food items have increased considerably, except in December 2013 when they declined sharply, together with a rise in wheat prices.
Although the fiscal measures have adversely affected inflation outlook for FY14, they will help reduce budgetary borrowings from the banking system and thus inflationary pressures in the medium term.
Thus, the recent uptick in inflation is a cost of delayed fiscal adjustment. The important point is that the risk of demand-driven inflation is still rather moderate. For instance, the year-on-year Non Food Non
Energy (NFNE) inflation is 8.2 percent in December 2013; marginally up from 7.8 percent in June 2013.
This is because economic activity has remained quite sluggish over the past few years. It will take some time before expected pick-up in economic growth pushes up aggregate demand.
Nevertheless, SBP expects average CPI inflation for FY14 to fall between 10 to 11 percent, which would be higher than the target of 8 percent announced by the government.
Other than attending to external sector risks, the reason for recent increases in the policy rate was also to manage expectations in the wake of expected inflation remaining higher than the target and restrict decline in real interest rates.
In September 2013, the SBP also linked the minimum rate of return on average balances held in saving deposits with the floor of the interest rate corridor. Specifically, the return on saving deposits cannot be more than 50 bps lower than the floor of the interest rate corridor, which is currently 7.5 percent.
This policy intervention ensures that deposit rates respond more strongly to policy rate changes. This would help in deposit mobilization and maintaining a reasonable growth in deposits necessary to meet the credit requirements of the economy.
The credit availed by private sector businesses have responded to reductions in policy rate during the last two years and relative improvement in availability of electricity to productive sectors.
During the first five months of current fiscal year private businesses have borrowed Rs161 billion, of which Rs38 billion is for fixed investment, compared to Rs16 billion in the corresponding period of last year.
Substantial credit uptake by sectors such as textiles, electricity, gas, and water and commerce and trade has been observed. Improving financial position of major corporate sectors along with higher expected demand for their products and improvement in net NPLs to net loans ratio may help in sustaining this initial uptake going forward.
Due to its accelerated growth, the contribution of private sector credit in expansion of Net Domestic Assets (NDA) of the banking system has increased to 37.0 percent during 1st July – 27th December, FY14, which is considerably higher than 14.2 percent during the corresponding period of FY13.
However, fiscal borrowings for budgetary support continue to dominate overall monetary expansion for the same period. Moreover, unlike last year, all of these borrowings are from the SBP.
Specifically, in net terms, the fiscal authority borrowed Rs612.4 billion from the SBP and retired Rs18.5 billion to the scheduled banks.
This is because banks were not offering sufficient funds at market interest rates prevailing at the beginning of FY14.
Increases in policy rate in September and November 2013 have helped the fiscal authority in raising sufficient funds from the scheduled banks, albeit mostly in 3-month T-bills, and retiring some of their borrowings from the SBP in Q2-FY14.
This, together with declining foreign exchange reserves, has kept the market liquidity conditions tight and at times volatile. The result is that short-term market interest rates remain on the higher side compared to increases in the policy rate.
Nevertheless, the quarterly flow of fiscal borrowings from the SBP has remained positive in both quarters of H1-FY14. This does not bode well for the effectiveness of monetary policy.
The SBP expects that government will keep these borrowings in check in H2-FY14 and lower outstanding stock gradually as stipulated in the new IMF program. The growth in broad money (M2) based on the expected developments in various sectors of the economy is projected to remain between 13 and 14 percent.
Containment of fiscal borrowings from the SBP would increase borrowing requirements from the scheduled banks. Timely receipt of budgeted foreign inflows could provide some respite; however, consistent reduction in the size of the fiscal deficit is critical for medium term macroeconomic stability.
This would require significant tax, expenditure and debt management reforms. A persistently high fiscal deficit has already resulted in accumulation of short-term domestic debt at a very rapid pace; 27 percent on average during the last three fiscal years.
For FY14, the government has announced a fiscal deficit target of 6.3 percent of GDP and managed to contain it at 1.1 percent of GDP during Q1-FY14. This is a positive start that needs to continue not only during remaining months of this fiscal year but also in the medium term.
A key risk to the fiscal position is a possible shortfall in tax revenues, recurrence of energy sector circular debt, and delays in budgeted foreign inflows. Such deviations could lead to increase in borrowings from the banking system, further accumulation of domestic debt and higher-inflation.
Although there are some risks to the balance of payments position due to uncertainty surrounding expected foreign inflows, expected increase in inflation is slightly lower than anticipated earlier.
In view of the above, the Board of Directors of SBP has decided to keep the policy rate unchanged at 10.0 percent....
To a question the governor said the central bank enjoyed independence and free hand so far its Monetary Policy is concerned.
Replying to another question, he said the Currency Swap Agreement Line with China had proved very helpful to Pakistan. Originally it was for three years, Anwar said further.
Such an agreement with Turkey is in the pipeline and would be good for both the countries, he added.
