Monetary Policy Decision

Economic Review, November 2009 | Go to article overview

Monetary Policy Decision


Macroeconomic considerations and outlook that influence monetary policy decision depict a mix picture. While inflation (YoY) and balance of payment position has improved, fiscal and real sector performance remains tenuous. Domestic financial markets functioned adequately but lending to the private sector has remained subdued. From a forward looking perspective, expected improvement in the external current account and emerging global economic recovery augur well for Pakistan's economy. But, limited progress on electricity shortages and stressed fiscal position dilute some of the optimism. Similarly, inflation outlook is not completely benign yet as depicted by recent monthly trends. Under these circumstances, assessment of balance of risks continues to be somewhat uncertain.

Both CPI and core inflation have declined further in August 2009, with former at 10.7 percent and Non food Non energy (NFNE) measure of the latter at 12.6 percent on year-on-year basis. But, the pace of decline in inflation was less than expected. The monthly increase of over 1.5 percent in CPI inflation in the first two months of FY10 is still quite high and of concern. This monthly increase coupled with administrative issues in the supply chain of food items and projected increases in electricity prices to eliminate subsidies could have a bearing on the behavior of domestic inflation in the coming months. Increase in international oil prices remains an underlying risk to inflation as well.

However, the likely presence of Ramadan seasonality in the CPI index, especially the food basket, and disproportionate contribution of only a few items calls for caution in interpreting recent monthly inflation indicators. Similarly, the effect of cost push shocks like electricity and oil on inflation may be neutralized by below capacity economic activity and slow aggregate demand. Moreover, expectations of inflation are likely to remain in check while the stabilization program remains on track. While it is likely that inflation will continue its secular decline, as observed in our last communication, there are risks to watch as we go forward.

Tapering aggregate demand pressures in the economy can be clearly seen in persistent and widespread decline in imports. Supported by continued strong inflow of worker's remittances, this fall in import growth has resulted m a modest surplus of $82 million in the external current account for August 2009. Even the cumulative July-August, FY10 external current account deficit of $527 million is much lower than earlier projections.

Similarly, on the back of favorable revisions regarding outlook of Pakistan's economy by international rating agencies, portfolio inflows are now positive; $55 million in the first two months of FY10. This, together with inflows from the IMF, both for budgetary support ($745 million) and allocation of increased Special Drawing Rights (around $1200 million), and adequate, though lower, foreign direct investments substantially improved the external financial account. Resultantly, the SBP's foreign exchange reserves have increased to $10.9 billion as on 28th September, 2009 - an improvement of $ 1.8 billion since the beginning of FY 10 and are reflected in Rs 123.6 billion increase in the Net Foreign Assets (NFA) during 19th July-19th September, 2009. This has helped liquidity conditions in the economy and translated into bringing stability to the foreign exchange market This improvement In balance of payments is despite a significant shortfall in non-IMF official financial inflows. …

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