SBP maintains DR at 14%- Optimism on various fronts

DR- Status quo maintained: SBP in its latest Monetary Policy Statement has decided to hold Discount Rate (DR) at 14%.

Fiscal weaknesses and inflationary pressures necessitate tight stance… Persistent GoP borrowing from SBP to finance flood and security related expenditures along with flood induced food inflation fuelled inflationary pressure and kept headline inflation during 1HFY11 at 14.6%. Both unsustainable fiscal position and high inflation pose risks to overall macroeconomic stability and provoked SBP to adopt a proactive policy stance.

…But recent positive developments allow for a pause: Despite a lack of improvement in the fiscal situation and relentless inflation, certain developments such as GoP commitment to limit borrowing and Current Account improvement have convinced SBP to take a wait and watch approach.

Future direction dependent on implementation of key reforms: Since structural issues still remain a concern, SBP will continue to take stock of progress on fiscal reforms and accordingly set future policy direction. In our view, this pause maybe one-off, given the doubts regarding sustainability of the aforementioned developments. With increasing revenue-expenditure gap, and political pressure to hold fuel prices at current levels, we believe trend in GoP borrowing will hold, causing inflation to remain in double digits in 2HFY11 and could provoke SBP to further hike DR.

Fiscal weaknesses and inflationary pressures necessitate tight stance…

High flood and security related expenditures have caused government to borrow persistently from SBP, aggravating fiscal position and stretching fiscal deficit to PKR500bn during 1HFY11 (revised target of PKR812bn). While GoP borrowing induced demand driven inflation, floods spiked food prices, further adding to inflationary pressure. Headline inflation during 1HFY11 was recorded at 14.6%. Both unsustainable fiscal position and high inflation pose risks to overall macroeconomic stability and have so far forced SBP to adopt a proactive policy stance.

But recent positive developments allow for a pause

Despite a lack of improvement in the fiscal situation and relentless inflation, certain developments have convinced SBP to take a wait and watch approach. These include 1) GoP’s commitment to limit borrowing from SBP to PKR1,290bn (Sep-10 level) 2) Improvement in external account (USD26mn Current Account surplus in 1HFY11) 3) GoP initiatives to curb expenditures and improve revenues.

Future direction dependent on implementation of key reforms

Since structural issues still remain a concern, SBP will continue to take stock of progress on fiscal reforms and accordingly set future policy direction. In our view, this pause maybe short lived, given the doubts regarding sustainability of the aforementioned developments. We believe GoP’s commitment to limit borrowing is indeed encouraging, but since the establishment is under extreme pressure from both opposition and coalition partners to provide public with some economic relief, that may eventually cause GoP to shoulder the burden of higher oil prices, seriously undermining its ability to fulfill the said commitment. Hence unless GoP is able to enact tax/fiscal reforms or negotiate foreign aid, we believe borrowing from SBP will remain on the higher side, causing inflation to remain in double digits and could provoke SBP to further hike DR during 2HFY11.

Economic & Political News

Stalled loans: IMF officials arriving today

Two top officials of the IMF, Adnan Mazari and Masood Ahmed, will arrive in Islamabad on Sunday to hold talks for a fifth review of Pakistan’s economic performance for provision of an installment of USD1.7bn under the standby arrangement. An IMF team’s visit to Pakistan will be finalized after the visit of Mazari and Ahmed. These officials are expected to meet Finance Minister Dr Abdul Hafeez Shaikh and political leaders to decide on a schedule for the fifth review.

Parliamentary body meeting: decision on oil prices hike likely today

The parliamentary committee on oil pricing is due to meet today to decide about increase in oil prices.
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