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COMMENT: Can the discount rate hike curb inflation? -Muhammad Aftab.

Pakistan, Aug. 9 -- To foot the bill of reconstruction of flood destruction and continue the war against terror, the people have to pay taxes, which should be equitable

Can the latest hike in discount rate curb inflation and help bridge the government's yawning budgetary deficit? Highly doubtful. I say this while looking back at nearly two years of the operation of a failed tight monetary policy.

But the hard fact is that the latest discount rate hike again hits business - already slowed by high interest rates and rising cost of doing business. The unsavoury part of it is that it comes just as Ramadan is starting, and businesses, especially those selling food items, have raised their prices. More of this is likely to happen as the month of fasting proceeds. So much for the so-called 'Islam-loving' big businesses and small vendors. It punishes consumers, especially when food prices are going up in the wake of the flood devastation. It, too, has political implications for the government.

The State Bank of Pakistan (SBP) has raised the benchmark discount rate from 12.50 to 13.00 percent, which will be effective until September 30. It targets the rising inflation and will help the government bridge its widening budgetary deficit. Its immediate impact: the six-month benchmark Karachi Inter Bank Offered Rate goes up from 12.16 to 12.76 percent. The commercial bank lending rate for big corporate firms rose from 14 to 15 percent and for others from 16 to 17 percent a year.

The central bank adopted the present tight monetary policy in November 2008 to contain inflation, but it goes on rising. Consumer Price Index (CPI) inflation, the SBP estimates, will be between 11 and 12 percent during the current fiscal 2011. But analysts estimate inflation will remain at 12.8 to 13.8 percent during the first six months of FY 2011 and then it may fall to 10.6-12.3 percent. Inflation in FY 2010 was 11.7 percent or 2.7 percent higher than the target. The broad money is projected to grow by 13 percent in FY 2011, up from 12.6 percent in FY 2010 against 9.56 percent in FY 2009. It will again spike inflation, and increase the cost of doing business. It is already the "highest in the region".

Acting Governor of the SBP, Anwar Yaseen, says the discount rate has been raised "on the assumption that most fiscal targets of the government will be missed". Islamabad will have to borrow heavily from the SBP and the banking system to meets its budgetary deficit. "It will cause inflation and monetary expansion. The discount rate has been raised to mitigate risks to macroeconomic stability," Yaseen says. The budgetary deficit may exceed the projection of five percent of GDP. The FY 2010 deficit target of 5.1 percent was also missed, as the actual was more than 6.0 percent. The projected deficit in FY 2011 will force the government to borrow heavily; it will reduce the commercial banks' liquidity to lend to the private sector at a time when industry output, particularly of large scale manufacturing (LSM), is looking up. Business needs a boost too to overcome the energy crunch and the law and order problem.

External balances are likely to come under pressure as well. Recovery in the domestic economy and an expected increase in international commodity prices will push import growth to increase 12 percent in FY 2011, as against a decline of 2.3 percent in FY 2010. Similarly, the export growth in FY 2011 is projected at around 7.0 percent, compared to 2.7 percent in FY 2010. Actual imports in FY 2010 were $ 34.710 billion, and exports were $ 19.382 billion.

While the economy needs to grow, investment is down. "As a percentage of GDP, it declined for three consecutive years, falling to 16.6 percent in FY 2010," the SBP says. But the saving grace was national savings, which improved on the back of an increase in the inflow of home remittances of overseas Pakistanis. The inflow in FY 2010 was $ 8.906 billion - up from $ 7.811 billion in FY 2009. To foot the bill of reconstruction of flood destruction and continue the war against terror, the people have to pay taxes, which should be equitable. All categories of production will have to be raised. That will check inflation and narrow the budget deficit. Enormous tasks! Will the government, and the people, rise to the occasion?

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Publication:Daily Times (Lahore, Pakistan)
Date:Aug 9, 2010
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