Addressing the media at the SBP head office, State Bank of Pakistan Governor Dr Shamshad Akhtar said: "Active and calibrated liquidity management is a part of prudent monetary management, necessary to ensure effective monetary transmission mechanism, which is critical to advancing financial as well as overall macroeconomic stability." As such, these money market measures must not be construed as a change in SBP's monetary policy stance, she added.
The Governor said that monetary tightening was warranted to reduce the external current account imbalance, reinforce fiscal tightening and discipline, arrest rising inflationary pressures, build up the foreign exchange reserves and calming the foreign exchange market, besides restoring confidence and stability in money markets and demand pressures.
She said that raise in the policy rate by 200 basis points was not an easy decision for SBP, and in the post-July 2008 period the SBP had taken a number of measures, at appropriate times, and in phases, to avoid other attendant risks.
However, she said, the ever-highest 25 percent inflation and micro economic imbalances had compelled the central bank to take some strict measures, aimed to improve the sovereign guarantee. Otherwise, the country' economy would have faced more difficulties on both domestic and international fronts, besides decline in the foreign inflows.
She said that despite $2.3 billion workers' remittances and $7.1 billion exports, the import bill of $12.9 billion had raised external current account deficit to $5.9 billion during July-October FY09. With financial inflows slowing down ($1.1 billion only in July-October FY09), the external current account deficit had to be financed by drawdown of SBP's foreign exchange reserves, she added.
As a result, the country's foreign exchange reserves has been reduced by $5.0 billion since the beginning of this fiscal year, up to Nov10, 2008. The recent decline in international oil and other commodity prices were a positive signal for the external sector. However, a sustained decline in overall imports demand was critical to avoid further reserves loss after its expected build-up.
Dr Akhtar said that SBP's new move would not only help in aligning aggregate demand with supply but would also provide room to accommodate the government's financing requirements from commercial banks. In addition, this would help calm the sentiment in the foreign exchange market and would also stem the second-round impact of high inflation from spreading further, she said.
She added that appropriate monetary policy stance was only one ingredient of the macroeconomic stabilisation program and, as such, its effectiveness would depend on co-ordinated fiscal and external sector actions to ensure swift and sustainable stability.
"Economic outcome during first four months of FY09 has deviated substantially from our expectations, and increasing public sector spending, imports and inflation are three principal factors complicating macroeconomic management," the Governor said.
She said that government budgetary borrowing from the SBP had reached up to Rs 369 billion during period from July 1 to November 8, 2008, while import bill had gone up by 35.2 percent, and headline and core inflation had mounted to 25 percent and 21.7 percent, respectively, in October 2008.
She said that recognising the continuing economic challenges and complexities, Pakistan has launched a comprehensive macroeconomic stabilisation package for the medium term to curb the growing macroeconomic imbalances and strengthen the fiscal and monetary co-ordination. It is also expected to facilitate official and private foreign inflows, which are critical to stabilise and build up the foreign exchange reserves to an adequate level, she added.
The Governor said that the crux of this program revolves around reducing the external current account deficit, supported with appropriate exchange rate policy and bringing the fiscal deficit to sustainable levels by rationalising expenditures and strengthening tax revenue generation.
This stabilisation package will help to proactively manage supply and demand pressures, which are critical to restoring economic confidence and stability. The need for an effective macroeconomic stabilisation package had heightened early in the year as the economic indicators came under stress because of the impact of global commodity price hikes combined with a persistent rise in aggregate demand pressures.
Challenges and risks have magnified as the unanticipated adverse macroeconomic outcome of FY08 persisted and spilled over into FY09 compelling the central bank to take some more steps, she said.
Dr Akhtar said that Pakistan's economic situation is different from global and regional developments. Therefore, policy responses have to be different. She added that "the world is in grip of the worst financial crisis, while a number of advanced countries are facing severe liquidity crisis, which transformed into an insolvency crisis".
In contrast, Pakistan, hit by the global commodity price shock, and given the delays in passthrough of this price effect, witnessed a growth in its fiscal and external current account deficits that reached unsustainable levels and alarmingly high inflation.
She said that stagnating tax-to-GDP ratio had not only enhanced recourse to borrowings from the SBP but also resulted in a fall in foreign exchange reserves, triggering depreciation in the exchange rate.
"Considering the size of macroeconomic imbalances, the SBP remains committed to achieve price stability over the medium term and thus has to launch steeper monetary tightening to tame the demand pressures and restore macroeconomic stability in FY09" the Governor said.
She said that recognising the economic challenges and given the macroeconomic outcome, there was need to extend the macroeconomic stabilisation program to mitigate the emerging risks. "Similarly, though import growth is expected to significantly slow down to 2.0 percent (and may even turn negative) due to falling international prices and exchange rate induced domestic demand moderation, the external current account deficit is projected to lie between 6.2 to 6.8 percent of GDP," she added.