Excerpt from the statement by the Central Board of Directors of SBP:
While the challenges for macroeconomic stability in the external sector remain, the fundamentals of the economy going forward in the backdrop of the recent policy and reform measures appear stable. Notwithstanding rising inflation, the prospects of an economic revival inspired by successful political transition and the resolution of energy related circular debt issue are encouraging. To ensure the economy remains on a stable path, further structural reforms are in progress. Although, it is too early to conclude about their impact, there are some indications of a pickup in economic activity. The growth in LSM has accelerated with a year on year increase of 8.4 percent during Q1-FY14. Similarly, exports have also marginally picked up, growing at 1.3 percent in Q1-FY14.
The deterioration in the external accounts has continued in FY14, largely on account of weak financial inflows. With imports picking up at a relatively higher pace than exports, the widening of the trade deficit mainly explains this.
The speculative sentiments on account of IMF end September 2013 targets resulted in exchange rate volatility. Such sentiments are an attribute of uncertainty over foreign exchange flows, which are expected to be reduced with sustainable improvement in the external accounts. In this regard, the progress on reforms part of the IMF program is likely to play a critical role.
Successful completion of structural benchmarks under the IMF program will also ensure additional financial inflows from other IFIs. In the absence of such reforms, the burden of adjustment falls disproportionately higher on interest and exchange rates that may perpetuate speculative sentiments in the market.
An increase in inflation while keeping the market interest rates at the current level can increase the incentive for borrowings and discourage savings in the economy. This can potentially increase demand pressure through consumption as well as dampen investment, and thus the productive capacity of the economy. In addition, with fragile external flows, negative real return can encourage outflow of foreign exchange increasing the pressure on exchange rate.
The Central Board of Directors of the State Bank of Pakistan has decided to increase the policy rate by 50 basis points to 10 percent to take effect 18th November, 2013.