The Central Board of Directors of the State Bank of Pakistan at its meeting
held under the Chairmanship of SBP Governor, Mr. Yaseen Anwar in Karachi today has decided to keep the policy rate unchanged at 12 percent. The State Bank has also decided
to raise the minimum Profit Rate on PKR Saving/PLS Saving Products from 5.0 to 6.0 percent.
‘It was the expectation of SBP that these deposits will respond to market forces and adjust accordingly. The rigidity of
the deposit rates, especially for
small savers, is adversely impacting the savings-investment ratio of the economy, the
State Bank of Pakistan said
in its Monetary Policy Decision.
It said that a more balanced risk-reward incentive structure is warranted
in the shape of
appropriate deposit rate structure, as the savers, especially the smaller ones,
need to be adequately compensated. ‘Therefore, it has been decided that, effective May 1st, 2012, all Banks are required to
pay
a minimum Profit
Rate
of 6.0 percent on PKR Saving/PLS Saving Products,’ it added.
Following is the complete text of
the Monetary Policy Decision:
‘As the economy begins the last quarter
of current
fiscal year, SBP’s monetary management continues to play its part in balancing the implications
of
multiple challenges faced by the economy. The primary consideration remains bringing
inflation further down as it has persistently remained in double
digits in the last few years.
Ensuring smooth functioning of the payment system and financial stability is
also important given the current stressed liquidity conditions in the market. Similarly, elevated international
oil
prices, weak quantum of exports, and insufficient
foreign financial flows require careful
management of
the external position.
Last
but not least, the consistent decline in private investment
is also an important factor in formulating the monetary policy strategy as it impacts both the medium term inflation, growth and employment prospects.
Given limited
set of instruments, not all these challenges can be effectively tackled by monetary policy alone. There are bound to be tradeoffs involved among these competing considerations.
A supporting fiscal strategy
and
an active economic reform agenda is critical to deal with some of the structural issues, in particular, low tax
to GDP ratio and
energy shortages. Most importantly, the
economy needs a forward-looking approach to policy making with strict adherence to rules laid out in the legal frameworks, be it the State Bank of Pakistan (Amendment) Act (2012) or Fiscal Responsibility
and
Debt Limitation (FRDL) Act
(2005).
Following this approach
is crucial in anchoring
inflation expectations around
the
medium term
targets of 9.5 percent for FY13 and 8 percent for FY14 as envisaged in the Medium Term Budgetary
Framework (MTBF) of the
government. In March 2012 the year-on-year CPI inflation was 10.8 percent and, given the current economic conditions, is projected to remain in double digits during
FY13. Consistently growing government borrowing requirement from the banking system is a key variable that is adversely affecting the inflation outlook. Weak private demand, on the other hand, is one reason why inflation
is not increasing
sharply. Nonetheless, the size of fiscal
borrowings and
lack of investment is
eroding the
medium term productive capacity of the economy, contributing towards persistence of
inflation in early double digits. Another risk factor that needs to be monitored closely for assessing inflationary pressures is the behaviour of international oil
prices.
The current year government borrowings for budgetary support have been Rs373 billion from the scheduled banks and Rs218 billion from the SBP during 1 July – 30 March, FY12. The year-on-year
growth in these
borrowings turns out to be 56.5 percent and 18.5 percent respectively. The year-on-
year
growth in the private sector credit, on the other hand, was only 4.2 percent and that in total
deposits
of
the banking system was 17.4 percent during the same period. Thus, despite a decent growth in deposits, the banks continue to prefer financing
the fiscal deficit as opposed
to searching avenues,
taking risk, and building partnerships to facilitate credit to the private sector. The cost to the
economy is
visible in terms of a decline in investment to GDP ratio to historically low levels and stagnant economic growth that is
considerably lower than the economy’s potential.
If a revival in private sector credit and growth prospects is
to take place, a pertinent question in
the current circumstances is: how would the government
rollover its maturing short-term debt and
raise additional
financing while
simultaneously
retiring
its
borrowings
from the SBP?
With shortfalls
in
external sources, the most likely avenue will be more borrowings from the SBP. The inflationary implications of
this
scenario should not be underestimated. However, according to the recent State Bank of Pakistan
(Amendment) Act (2012), government borrowing from the SBP is required to be repaid at the end of each quarter and the existing stock is
to
be retired within eight years. In case of not observing these
provisions, the Act
also stipulates that the federal government will submit a statement to the
Parliament
giving detailed justification.
Adherence
to this legal requirement, without serious adjustment in the fiscal position, would lead
to significant injections of
liquidity by the SBP to keep the payment
system functioning and financial
markets stable. But, SBP is already injecting substantial short term liquidity in the system, Rs200 billion as of 13 April 2012, which is being continuously rolled over. The permanent nature of these injections
also potentially carries inflationary
risks. Thus, simultaneously
meeting the legal requirement of zero quarterly borrowings from SBP, scaling back liquidity injections, effectively anchoring
inflation expectations, and creating
space for the private sector, could prove to be a much more difficult task
than appreciated.
Government borrowing requirements are not the only source
of liquidity pressures. With a
gradually rising external current account deficit and consistently declining foreign inflows, the SBP’s
foreign exchange reserves are on
a declining
path. During
the first eight months of FY12, the external
current account deficit was $3 billion while the net capital and financial account receipts were only $187
million. Not surprisingly, SBP’s liquid foreign exchange reserves have declined
to $11.8 billion by end-
March 2012 from $14.8 billion
at end-June 2011. These
external sector developments are exerting downward
pressure on rupee liquidity as indicated by a 21.4 percent year-on year decline in Net Foreign
Assets (NFA) of the banking system by
end-March 2012. Thus,
some rupee liquidity injection and
increase in reserve money is
required
to
facilitate normal transactions
taking place in the economy.
Further,
SBP’s operational monetary management framework sets the short term interest rate
or
the price of liquidity based on broad macroeconomic considerations such as likely inflation path relative to the announced
target. The requirement of liquidity and thus growth in reserve money is residually determined and provided to ensure smooth functioning of financial markets. The SBP cannot
simultaneously
set both
the
interest rates
and money growth. The
challenge is if
the underlying behaviour of a significant user of money does not respond to interest rate signals, then monetary policy would become ineffective in achieving its objectives.
Given substantial
external debt payments, declining
trend of export quantum, elevated international oil prices,
and weak financial
inflows, the external position is likely
to
remain under
pressure in the remaining part of FY12 and FY13. Similarly, provisional financing data indicate that the
fiscal deficit may have reached 4.3 percent of GDP during the first nine months
of
FY12. Given the last quarter seasonality, a substantial slippage compared to the revised target of 4.7
of GDP cannot be ruled
out. Both these developments would have implications for variables that concern monetary policy such as inflation expectations, liquidity pressures, and private investment. In terms of
solutions, the economy
needs deep and
decisive fiscal and energy sector reforms and
an early realization of planned foreign financial inflows to mitigate uncertainty.
Another
area of reform is
to
improve
financial
deepening and
competition in the banking
system. In this
vein, SBP has already been encouraging depositors to put their savings in government securities through Investor’s Portfolio Securities (IPS)
accounts. Among other objectives, this is expected to lead to better returns on deposits over time. Moreover, in May 2008, SBP introduced a minimum 5
percent floor on all categories of Savings/PLS Saving Products. Consequently, average deposit rate of all saving related
products
increased from 2.1 percent
to
5.25
percent,
with no
significant change
thereafter. The saving deposits category now account
for
38 percent of all bank deposits and 52 percent of
total number of
deposit accounts.
It was the expectation
of
SBP that these deposits will respond to market forces and adjust
accordingly. The rigidity of
the deposit rates, especially for
small savers, is adversely impacting the savings-investment ratio of the economy. A more balanced risk-reward incentive structure is warranted
in the shape of appropriate deposit rate structure, as
the savers, especially the smaller ones, need to be adequately compensated.
Therefore, it has been decided that, effective May 1st, 2012, all Banks are required to pay a
minimum Profit Rate of
6.0
percent on PKR Saving/PLS Saving Products. At the same time, given the overall macroeconomic conditions, the Central Board of Directors has decided
to keep the policy rate unchanged at 12 percent.’
