KARACHI (HASSAN JAWWAD) - The Central Board of Directors of the State Bank of Pakistan, at its meeting held under the chairmanship of SBP Governor Yaseen Anwar on Friday, cut its policy rate by 50 basis points to bring it down from 10 percent to 9.5 percent with effect from December 17, 2012.

According to the monetary policy decision, the decline in CPI inflation is considerably faster than earlier estimates. The year-on-year CPI inflation for November 2012 stands at 6.9 percent, with food inflation dropping to 5.3 percent and non-food inflation coming down to 8.1 percent. Even the core inflation measures are in single digits.

This broad-based deceleration in inflation is now expected to keep the average inflation for FY13 below the 9.5 percent target for the year. Therefore, the Central Board of Directors of SBP has decided to reduce the policy rate by 50 basis points to 9.5 per cent with effect from December 17.

According to the policy statement, both the level of interest rate set by the SBP and the timely realisation of budgeted foreign inflows are critical in managing the balance of payment position. The lower interest rate can potentially affect the credit demand, including that of imports, and return on rupee-denominated assets relative to foreign currency assets.

The first consideration is not a source of concern at the moment given the weak overall credit conditions and consistent decline in the quantum of imports. The second consideration is important and puts a natural limit on downward adjustments in the interest rate. However, it needs to be weighed against the expected budgeted foreign inflows which are not linked with the interest rate, but can boost much-needed financial inflows.

The timely realisation of these official inflows is of essence and can alleviate the fiscal pressure on domestic borrowings to some extent. Showing a year-on-year growth of 26.4 percent, these fiscal borrowings from the banking system continue to remain the main source of monetary expansion.

The consistently low level of credit availed by the private sector together with declining foreign investments are the main factors responsible for a stagnant economy. The persistent energy shortages have already decreased the utilisation of productive capacity of the economy.

Agencies add: The cut in benchmark interest rate by 0.5 percentage points to 9.5 per cent was in the light of a fall in inflation.

The International Monetary Fund, though, has projected inflation to return to double digits by next year, which would complicate the task of the central bank as it tries to boost growth ahead of elections next spring.

The IMF expects Pakistan's gross domestic product to grow 3-3.5 per cent over the next financial year - not enough to provide jobs for the rapidly growing population.

Chronic gas and electricity shortages, violent crime and a Taliban insurgency have all hampered growth and contributed to falling foreign investment.