Money and Banking

SBP undertook aggressive monetary tightening during FY09, further increasing
the policy rate by 300 bps in two rounds. On a cumulative basis, this means a 550
bps increase during the last 18 months. These policy measures were in response to
The State of Pakistan’s Economy
8
carryover of macroeconomic stresses of the preceding year, which had grown in
size during the current year. For example;
(1) Although YoY CPI inflation declined from its peak, domestic inflation has
remained high. While the surge in food prices have retreated somewhat,
non-food inflation shows little effect of the sharp decline in international
commodity prices.
(2) Furthermore, external current account deficit, which was mainly reflecting
domestic demand pressures, increased sharply during FY09. There is a
risk that possible weakening of exports and remittance inflows may even
offset the anticipated relief in overall import bill for the country due to
recent broad-based decline in international commodity prices.
(3) Moreover, continuing monetization of the deficit was not only providing a
stimulus to domestic demand but has also greatly diluted the impact of
earlier monetary tightening. Government budgetary borrowings from the
central bank during Jul-Nov 2008 reached Rs 356.4 billion, as compared
to Rs 169.4 billion in the same period last year.
The excessive government borrowings from central bank posed difficulties in
liquidity management, which became more complex due to (1) a substantial drain
of the rupee liquidity from the inter-bank market by October 2008 following
substantial pressure on external account; (2) a heavy withdrawal of deposits owing
to seasonal cash demand around Eid, and (3) rumor-induced panic withdrawal of
deposits in October 2008. This induced SBP to announce a number of temporary
measures to accommodate liquidity shortfalls.
In terms of monetary aggregates, the YoY growth in M2 decelerated steeply to
10.7 percent by end-November 2008 – the lowest growth seen during the last
seven years. Indeed, an extraordinarily strong contraction in net foreign assets
(NFA) of the banking system more than offset a sharp rise in budgetary
borrowings from the central bank and continued strong demand for credit (both
from public sector enterprise and private sector).