July 26, 2015
News
State Bank keeps policy rate unchanged at 6.5%
* GDP growth of 4.2% in FY15 slightly higher than that of FY14, but still remains below the targetKARACHI: The State Bank of Pakistan (SBP) has kept the policy rate unchanged at 6.5% for the next two months, citing improvements in the macroeconomic indicators which are expected to sustain in the coming months despite destruction by floods in various parts of the country.
“The improvements in macroeconomic indicators have led SBP to continue with its accommodative monetary policy stance and slash the policy rate by a cumulative 300 bps in FY15,” SBP Governor Ashraf Wathra said while announcing the new monetary policy.
“The key factors facilitating this decision can be pinned down to a sharp decline in CPI inflation along with a benign outlook and improvement in the external account,” he said.
“Narrowing fiscal deficit and continuation of (International Monetary Fund’s) Extended Fund Facility improved the market sentiments. These developments also led to an upgrade in Pakistan’s sovereign ratings by international ratings agencies in recent months,” he added.
The bank said that the successful completion of reviews under IMF’s EFF program, issue of international Sukuk and disbursement of program related funding continue to support reserves building besides instilling stability in the foreign exchange market. The net SBP foreign exchange reserves rose from $10.5 billion at end-December 2014 to $13.5 billion as of 30th June 2015.
There is a possibility of upward revision in energy tariffs in FY16 and an adverse impact of floods on production of perishable food items going forward that could have an upward pressure on inflation.
The projections of high oil production and weak global demand suggest that international oil price might not have bottomed out yet. Given the recent behaviour of Pakistani CPI inflation amid falling international oil prices, this could result in keeping inflation on the lower side.
While GDP growth in FY15 at 4.2% was slightly higher than that of FY14, it remained lower than the target. In particular, industrial sector missed the target due to lower growth in large-scale manufacturing and electricity generation. However, the activities in construction and mining and quarrying remained buoyant. Agriculture sector despite some losses to major crops from untimely and heavy rains did manage to record some improvement whereas noticeable increase in growth, as in the previous few years, came in the services sector.
The expected higher consumption in low-interest-rate environment, planned increase in development spending and budgetary incentives for construction sector could provide some thrust to growth. Moreover, implementation of infrastructure projects planned under the China-Pakistan Economic Corridor (CPEC) and addressing structural issues especially related to energy and security would create favourable investment environment which is necessary to sustain economic growth.
Despite these positive developments, due to structural bottlenecks, sluggish global demand and lower commodity prices, exports contracted by 3.7% in FY15. Moreover, net foreign direct investment (FDI) declined to 0.3% of GDP in FY15. More work, therefore, needs to be done in the coming years to attract investments.
In the short-to-medium term, nonetheless, the disbursements of program related funding and planned issue of Eurobonds are expected to support an upward trajectory in foreign exchange reserves. Therefore, net SBP reserves are projected to increase slightly above 4 months of imports by end-June 2016. Having said this, the need to revive private inflows and exports to sustain this trajectory in foreign exchange reserves remains there.
The revised FY15 budget estimates show fiscal deficit of 5%, lower than the previous year’s. The estimated reduction in fiscal deficit in FY15 is primarily due to improvement in tax revenues. Total expenditures, on the other hand, are estimated to remain higher than the budget estimates despite reduction in subsidies and lower interest payments. Achieving the FY16 fiscal deficit target of 4.3% depends on collection of estimated Rs 145 billion from gas infrastructure development cess and FBR revenue target of Rs 3,104 billion.
The deceleration in broad money (M2) growth from 15.9% in FY13 to 12.5% in FY14 has slightly reversed in FY15 to 13.2%. While net domestic assets (NDA) led the growth in M2, net foreign assets (NFA) decelerated in FY15. Despite better current account balance, deceleration in NFA of the banking system was a result of lower capital and financial inflows. Government reliance on banking system, specifically on scheduled banks, for its financing needs boosted the NDA of the banking system. Scheduled banks’ financing of both commodity operations and PSEs also witnessed higher flow in FY15 against FY14.
Private sector credit (PSC) increased by Rs 208.7 billion during FY15 as compared to Rs 371.4 billion in FY14. The major drag for PSC remains the structural bottlenecks and low commodity prices. In FY16, construction and real estate sectors showed promise as indicated by their continued credit uptake. The lagged impact of easy monetary policy of FY15 is also expected to positively affect the credit growth in the upcoming credit cycle in the first half of FY16. On supply side, possibly making lending slightly more attractive is the spread between WALR and three-month T-bill rates, that has edged up from 113bps (on average) in FY14 to 131bps (on average) in FY15.
The liquidity conditions in the Q3 of FY15 remained stressed but eased a bit in Q4 due to net retirement of government borrowing from banking system. Following the easy monetary policy stance, other market interest rates also posted decline almost throughout the second half of FY15. However, a change has been observed in the market sentiments since the release of inflation numbers for May 2015.
Following the improvements in the interest rate corridor (IRC) framework in May 2015, the SBP has ensured that the money market average overnight rate remains close to the newly introduced target (policy) rate at 6.5%. This led to an increase in both volume and frequency of open market operations. As a result, the overnight repo rate remained (on average) 2 bps below the policy rate of 6.5% in the post-May 2015 monetary policy decision period.
Courtesy www.dailytimes.com.pk