KARACHI – The State Bank of Pakistan on Saturday announced to keep its key policy rate unchanged at 12 per cent for the next two months in a bid to contain expected inflation in the second half of the fiscal year 2011-12.

The move came as fastest inflation in Asia after Vietnam curbs scope to ease policy and bolster economic growth.

Since the start of the fiscal year last July, the SBP has cut interest rates by 200 basis points, but kept its policy rate unchanged since October. The bank faces greater-than-expected drawdowns in its foreign exchange reserves and higher government deficit financing from domestic markets.

“Against this backdrop, the central board of directors of the State Bank today consider the 200 basis points reduction of policy rate already introduced in fiscal year 2012 to be appropriate and has decided to keep the policy rate unchanged at 12 per cent,” SBP Governor Yaseen Anwar said at a news conference.

Mainly because of debt repayments, the foreign exchange reserves fell to $16.69 billion in the week ending February 3, compared with a record $18.31 billion in July.

Yaseen added that a sustainable economic recovery called for increased domestic and foreign investment for which business confidence needed to be revived.

Anwar said the basic challenge faced by Pakistan’s economy was financing its fiscal and external current account deficits. “The size of these deficits may not be considered large given the current state of falling private sector investment demand in the economy. A reflection of overall low aggregate demand can be seen in the declining inflation trend, contraction in the real private sector credit, and falling volume of imports,” he added.

He said current account deficit widened to a provisional deficit of $2.154 billion in the first six months of the 2011/12, compared with a surplus of $8 million in the same period last year.

“The lack of diversified and sustainable financing sources has resulted in substantial borrowings from the banking system by the government and declining foreign exchange reserves,” he noted.

“This has squeezed the availability of credit for the private sector and increased the pressure on rupee liquidity. The SBP has been providing substantial liquidity on almost permanent basis, on average Rs230 billion during 1st of July 2011 to 9th of February 2012, to ensure smooth functioning of the payment system and avoid financial instability,” he added.

He said continuation of this trend, however, carried risks for effectively anchoring inflation expectations in the medium term.

The SBP governor said uncertain market liquidity flows had led to excess volatility in short term interest rates and increased the challenges of monetary management.

“A declining interest rate environment together with a relatively better growth in Large-scale Manufacturing (LSM) is expected to help the pickup in private sector credit,” he added.

He said full year expansion in credit to the private sector was expected to remain weak in FY12 despite interest rate reductions. “The year-on-year growth is already negative in real terms and indicates depressed private investment demand in the economy.”

According to the provisional data, the government had borrowed Rs 444 billion from the banking system in the current fiscal year so far to finance the fiscal deficit, he added.

He said provisional estimate of fiscal deficit for H1-FY12, from the financing side, showed a deficit of Rs532 billion or 2.5 per cent of GDP.

Yasin said risks to external position also increased due to worsening terms of trade, fragile global economic conditions, and continued paucity of financial inflows. “In addition, $1.1 billion are scheduled to be repaid to the IMF in H2-FY12.”

“Led by 33.7 per cent growth in imports of petroleum products on the back of elevated international oil prices, total imports have increased to $19.7 billion in H1-FY12.”

“The volume of imports remained muted, which indicates moderation in domestic demand pressures. Given the rising tensions in the US-Iran relations and political uncertainty in the Middle East region, the oil prices are unlikely to fall significantly in the near future and may even increase. Therefore, despite low volumes, imports are projected to grow in the range of 12.5 to 14.5 per cent for FY12,” he added.

Similarly, while the falling cotton prices played their part in sharper than expected slowdown in export receipts, $12 billion in H1-FY12, the volume of exports have also declined considerably. Assuming that these trends would continue in H2-FY12 export receipts are projected to show a decline of 3 to 5 percent in FY12, he noted.

“The foreign exchange reserves have already declined to $12.2 billion as on 9th February 2012 from $14.8 billion at end-June 2011. Similarly, the rupee-dollar exchange rate depreciated by 5.2 per cent in FY12,” Yaseen added.