ISLAMABAD, 26 July 2004 — The State Bank of Pakistan (SBP), the central bank firmly confirms, the interest rates will rise in the coming months but also assured, only a gradual increase to protect interests of the business.
Rising lending rates will be a major departure from two years of a low-interest environment that helped the business expand and the economy grow faster than even targeted. The low cost funds enabled the corporate sector and many companies, during 2003 and 2004, to strengthen their balance sheets, improve profitability, and invest retained earnings along with bank borrowings into expansion, modernization or higher capacity utilization. Several of these business initiatives were geared to enable Pakistani industrial production and exports to face up to the WTO regime and opening up of markets starting January 2005. Textile industry was one of the key focus of such initiatives.
The scenario SPB unveiled in its Monetary Policy Statement (MPS) for July-December 2004 — the first half of fiscal 2005 — is of a faster industrial and business expansion and larger imports and exports on the back of substantial availability of commercial banks’ credit to the private sector during the whole of fiscal 2005.
SBP’s own borrowing on behalf of the government of Pakistan (GoP) last week, at rates highest in two years, confirms that low-interest rates already are a gonner. It borrowed Rs.66.908 billion — equivalent to $1.14 billion — last week by selling benchmark 6-month Treasury Bills (TBs) at a weighted average of 2.5229 percent up from 2.0756 at the last sale on May 26. The cut off yield for accepted bids for TBs also rose to 2,5797 percent — up from 2.2306 percent at the last sale. The rates rose and confirmed that lending rates will go up, but gradually.
Likewise, the SBP- subsidized export credit, the Export Finance Facility (EFF) is likely to rise from August, by 0.5 percent to 3.5 percent-if not, more.
“The present rising trend of interest rates is expected to continue for some time to come in view of the decelerating foreign capital inflows, modest inflationary expectations, significant credit provision of Rs.200 billion for the private sector during fiscal 2005, and also rising interest rates in the international financial markets,” said MPS, unveiled last week. But it assured the business and Pakistan’s foreign trading partners who will be directly affected by costly credit, that “SBP will be quite vigilant and will make sure that the process of interest rate hikes is gradual and that it does not adversely impact the ongoing growth target of 6.6 percent set for fiscal 2005,” against 6.4 percent in 2004.
SBP’s two-year old Easy Money Policy (EMP) had brought down the lending rates, and expanded commercial banks’ credit to the private business. “The low-interest rate environment had pushed the TBs rate to an all-time low of 1.27 percent in August 2003. The average lending rate also had went down to a record-low of 4.69 percent in March 2004. As a result, the private business credit takeoff rose to an historic high of Rs.301.2 billion at the June closer of fiscal 2004, up from Rs. 152.2 billion in 2003.
The commercial banks’ liquidity situation in 2004 was not as comfortable as it was in 2002 and 2003 because of the fast dwindling net capital inflows from overseas. The liquidity declined also because of heavy advances to the private business. Domestic private credit demand has peaked in 2004. Therefore, the rate of expansion will be moderate but still a large portion of net domestic growth will be preempted by the private sector. The situation during 2004, led to a reversal of the direction of interest rates-from declining to rising.
The cut of yield from the 6-month TBs started to go up, rising 96 basis points to 2.23 percent during August-May, 2004. The cut off yields on other short-term government papers also rose by varying degrees. “The rising interest rates outlook is also reflected in the upward shift in the yields curve between August 2003 and June 2004,” the MPS shows.
What caused a reversal in the SBP’s two-year long easy money policy. In nutshell it is the rising inflation, fueling a lot of criticism by the public and independent economists, as “a high degree of unemployment,” prevailed as SBP itself admits, while wages stayed sticky. It dented the government’s claims of an “under three percent” official inflation rate, low cost of doing business in Pakistan, and reducing poverty, while some 40 percent people still live on less than a-dollar-a-day. Inflation was officially estimated at 4.0 percent at end-June, 2004. But the government’s actual Consumer Price Index (CPI), rose 8.45 percent year-on-year in June 2004. The SBP is now forecasting inflation at 5.0 percent for fiscal 2005.
In order to maintain a reasonable degree of stability in the exchange rate and the rupee-dollar parity, the central bank injected $461.8 million in the inter-bank market during March-June, 2004.
A gradual slide down of the rupee improved Pakistan’s export competitiveness, as the real effective exchange rate depreciated 2.8 percent in 2004, compared to 1.6 percent in 2003. It assisted exports to shoot across the $12.1 billion target to a record actual of $ 12.3 billion. The forex reserves rose 66.7 percent to $10.72 billion in 2003, and a further 15 percent to $12.233 billion in 2004 even though net capital inflows decelerated, and the government prepaid $1.17 billion of its foreign debt.
The pace of net capital inflows decelerated considerably during July-May period of fiscal 2004. It trimmed the overall balance of payments (BoP) surplus to $1.2 billion compared to the like period of 2003.
Remittances by overseas Pakistani, including those working in the Gulf, dipped 8.6 percent to $ 3.87 billion in 2004, although these were higher than the projected target of $3.6 billion. The actual remittances were $4.06 billion in 2003. But the FDI inflows rose 21.2 percent to $902.8 million.