SBP's Third Quarterly Review of the economy, issued on Saturday, states that unlike most Asian central banks and departing from its own past practice, the monetary tightening in Pakistan was not achieved through raising the interest rate.
The discount rate remained unchanged through FY 06, and even in auction yields on benchmark 6-month T-bills the rate was almost unchanged, witnessing a rise of only 50 basis points during the period. Instead, SBP focused on draining excess liquidity from the interbank market through very frequent OMOs.
As a result, the short-term interbank interest rates remained fairly close to the discount rate and contributed to an increase of 202 basis points in weighted average lending rates during July to May 2006.
The report says that the rise in interest rates had a visible impact on credit growth. Consequently by June 10, 2006, the major monetary aggregates were showing significant weakening compared with FY05.
The deceleration in growth in money supply, M-2, to 13.3 percent during June to July 10, 2006 from 16.2 percent in the same period in FY05 was entirely primary due to slowdown in private sector credit offtake.
While government borrowing during July 1, 2005 to June 10, 2006 from the banking system rose from 4.1 to 4.4 percent, credit to non-governmental sector during the period came down from 14.3 to 11.3 percent.
Besides the rise in real lending rates being a factor in slowdown of credit off-take, sectoral distribution of credit showed a reduction in credit to textiles and tapering of demand from telecommunication industries. This slowdown was despite the larger increase in trade related loans and private sector commodity finance during July-May FY06 compared with the preceding year. "This slowdown in the credit market appears to be driven by both demand and supply side factors," says SBP.
The SBP review also underlines a significant slowdown in import growth from February 2006 onwards. "The detailed analysis of the data shows that growth in major heads is much lower in February-May 2006 compared to July-January 2006. Furthermore, almost 80 percent of the growth in the February-May period is being contributed by two categories, 'petroleum' and 'other inputs.' The share of machinery in imports growth has gone down from 29 percent in July-January 2006 to five percent in February-May 2006.