Monetary Policy Statement January-March 2009 State Bank of Pakistan

Executive Summary Pakistan’s economy has started to show signs of the beginning to an end of a year long period of mounting difficulties and challenges, yet it has not solved all of its problems. The ensuing vulnerabilities and risks posed complex policy questions that occupied the country during most of 2008. The stress on macroeconomic stability was most visible in an unsustainable balance of payments position and the falling value of the rupee. Together with this, escalating CPI inflation, driven both by food and non-food components, and structural problems such as power shortages leading to a gradual decline in real economic activity, aggravated the pressure. The enormous size and skewed financing mix of the fiscal deficit that tilted heavily towards central bank borrowing, liquidity shortages in the money market, and strains in the overall banking system added to an already worsening situation. The domestic socio-political upheavals and rapidly changing global economic environment also contributed to these multifaceted problems. These diverse developments entailed complex interactions and led to an increasingly intricate menu of policy trade-offs. In response, and keeping in view the economic outlook for FY09, the SBP tightened the monetary policy further by increasing the policy discount rate by 100 bps in July 2008. The final judgment categorically stated that the risks to the inflation outlook were far greater than risks to economic growth and reckoned the necessity of well coordinated stabilization measures. Given the emerging liquidity issues, SBP also took a host of measures in October 2008 to address problems related to liquidity management by banks. In continuation of its resolve to support a return to macroeconomic stability, Interim Monetary Policy Measures were announced on 12th November 2008. The increase in the policy discount rate from 13 to 15 percent was taken after assessing the developments during the first four months of the current fiscal year and seeing no visible turnaround in the highlighted risks and challenges faced by the SBP. Tight monetary policy, however, was only one ingredient of the macroeconomic stabilization program; several stabilization and structural adjustments were required immediately and in the medium term to put the economy back on a stable path.More importantly, the Interim Measures outlined the contours of the macroeconomic stabilization program prepared by the SBP and the government. Since the corner stone of the stabilization program was an urgent need to plug the
‘financing-gap’ of $4.5 billion during FY09, a Stand-by Arrangement (SBA) was signed with the IMF towards the end of November, 2008 (see Appendix for details).Although it is too early to evaluate the benefits of all the measures that the stabilization program stipulates, yet by January 2009 there are early signs of improvement in the outlook for some important economic variables such as inflation, foreign exchange reserve, import growth, and government borrowings from the SBP. Two broad reasons underlie these positive developments.