KARACHI-The State Bank of Pakistan on Monday cut its monetary policy discount rate by 100 'basis points, to 14 per cent for the April-June quarter of the current fiscal year (2008-09) as anticipated by the monetary and financial experts. The new interest rate would be effective from April 21 (today). The Central Bank, however, kept unchanged the Cash Reserve Requirement (CRR) and Statutory Liquidity Requirement. Syed Salim Raza, Governor State Bank of Pakistan announced the new quarterly monetary policy at a Press conference here. Salim Raza said that the decision to reduce the key policy rate has been taken on the basis of evaluation that inflation will continue to come down in coming months. He said that the prospect of overall growth remains modest and the economy is expected to register a growth of 2.5 per cent to 3.5 per cent in FY-09. He said that the average inflation is expected to be around 14 per cent in Q4-FY-09 and 8 per cent in FY-10, which show positive prospects for easing monetary policy stance. Nonetheless, due to strong internal impact, average CPI inflation for FY-09 would remain around 21 per cent, he added. He mentioned the decreasing trend in inflation now appears robust as headline CPI inflation (YoY) has come down to 19.1 per cent in March 2009 from the peak of 25.3 per cent in August, 2008. He said that due to decline in the pace of inflation, banks depositors will get better profit rates on their deposits as real rates of return on deposits will start increasing once the inflation declines further during the upcoming months. Therefore, real rates of return will be come into positive digits, he added. He further said the cut in KIBOR will help the business and industrial sector to achieve better prospects of growth and development. He mentioned reduced domestic demand pressure, as evident in shrinking twin deficits, are expected to narrow the output gap and reduce inflation. However, supply shocks such as power shortages and worsening law and order situation may delay the eventual fall in inflation, he said. 'Infact, the persistence in inflation is largely due to these factors and is evident in various inflation indicators. Nonetheless, other supply side factors like falling international commodity prices and improved food supply coupled with strong expectations of low inflation in the near future will have a beneficial impact on current inflation, he added. He said that the countrys economy has made a steady progress on its path towards macro-economic stability. 'However, global recession, severe power outages and deteriorating law and order condition have taken their toll on domestic economic activities. He said in tandem with weak performance of commodity producing sector, services sector is also likely to show a weaker growth in FY-09 than the target of 6.1 per cent for the same fiscal. He also said that dismal performance of Large Scale Manufacturing (LSM) in July-February, FY-09 with negative growth of 5.7 per cent, and weaker than target growth of agriculture sector points towards the weaker real economic activities of commodity producing sector for FY-09. He said that the agriculture sector is expected to register a growth of 3.0 per cent due to better output of major crops in kharif season (particularly of rice and cotton) and expected bumper crop of wheat of around 23.5 metric tonnes. This will provide some grace to overall real GDP growth, though agriculture performance will be lower than the original target of 3.5 per cent, he added. 'LSM sector growth, in particular, the performance of export driven industries (particularly, textiles) has been negatively affected amid energy outages, deteriorating law and order situation, and most critically, weaker external demand due to the recessionary tendencies in most of the major trading partner countries. The domestic demand for automobile, electronics and other consumer durables has also remained weak which is attributed to high interest rates on consumer financing and increased risk averseness of commercial banks about consumer financing due to rising NPLs in this sector, he revealed. Talking about risks and challenges, he said despite considerable improvements in the external sector, its outlook remains a major source of concern. 'Not only the export performance is expected to suffer but any deviation from the expected financial inflows could send tremors to the rest of the economy. The risks for such deviations mostly emanate from the deepening global recession and domestic politico-economic environment, he added. He said that now it is certain that the global economy is bound to see a contraction in 2009. He further said:What is more important is to assess the extent of this decline, particularly in the major economies such as US, UK, euro-zone, and Japan, and speed of economic recovery. Although unprecedented monetary and fiscal stimuli have been announced, there benefits have not yet been materialised. If response of the real economy in these countries remains muted and if financial intermediation does not pick up to normal levels, the impact on the global economy could be much higher. Consequently, he said that the adverse effect on Pakistans economy through trade, remittances and financial inflows could be much more than expected today. 'The persistence of the global recession and credit market imperfections are likely to impact firms capacity and propensity to invest globally. This might reduce the chances of future investments in Pakistan and retrenchment in existing business activities. With increased risk averseness of foreign investors, the adverse impact on financial flows may turn out to be much higher than expected earlier, he added. 'Despite some modest improvement in the perceptions of Pakistans sovereign debt, the risk premium is still very high. This curtails Pakistans ability to tap foreign debt markets to finance its external current account deficit.With the aforementioned constraints on foreign private flows, Pakistan is depending almost entirely on sovereign bilateral and international financial institutions for financing needs, he said. He said that the immediate implication of adverse external developments is likely to be reflected in domestic financial markets as reduced flows in both the markets could put pressure on domestic interest rates and exchange rate. 'It also increases the risk of reducing the availability of credit for private sector. Moreover, the dependence of the govt on domestic financial markets could increase significantly. He said that in the wake of a considerable slowdown in domestic real economic activity, tax revenues are likely to fall short of the stipulated target, which may lead to fiscal slippages in the absence of rationalisation in current expenditures. Missing the revenue target may affect development spending and does not bode well for countrys considerable needs for investment in infrastructure. A related risk, given that further expenditure cuts may not be possible, is of a rise in the budget deficit and its financing through domestic borrowings. This may translate into crowding out of the private sector credit with renewed risk of inflation persistence, he added. He said that weakening of domestic and global environment can also increase the stress on Pakistans banking system. With higher credit concentration among few sectors, particularly textile, any sharp setback to textile sector may result in further rise in NPLs, he added. 'The Q4-FY09 T-bill auction calendar shows that govt will require an additional Rs 97 billion (over and above the maturing amount) from the scheduled banks to finance its fiscal deficit. He said that the improved fiscal discipline and contraction in the external current account deficit indicate that aggregate demand is showing a downward trend. Referring to the recent fiscal developments, he said that fiscal deficit of Rs 251 billion (1.9 per cent of projected GDP) for H1-FY-09 and the govts commitment to cap it at Rs 562 billion (4.3 per cent of projected GDP) for the entire FY-09 is a very significant improvement over last years 7.4 per cent. Likewise, he pointed out that external current account deficit has narrowed to $172 million in March, 2009 compared to a deficit of $2.2 billion in October, 2008, showing much improved trends in the external sector. He said that cumulatively, the external current account deficit for the first nine months of FY-09 stands at $7.6 billion and is projected to be $9 billion or 5.5 per cent of the full year GDP. He said that containment of these twin deficits has reduced demand pressures and helped to align, to some extent, the investment capacity of the economy with the limited availability of foreign and domestic savings. 'The impact of these adjustments is visible in monetary aggregates. The necessary steps of restricting govt borrowing from the SBP has restricted reserve money creation in the system as has the low, albeit gradually improving, foreign exchange reserve position, he said. He said that rise in SBPs foreign exchange reserves of $4.3 billion between November-April, FY-09 and projections that this level will increase to $9.1 billion by end-June, 2009 is also a key indicator of emerging macro-economic stability. SBP Governor said that tight monetary policy, together with the rationalisation of fiscal subsidies and expenditure controls, are the key policy actions that have delivered improvement in these deficits. 'The efforts of SBP and the govt to achieve macro-economic stability were also supported by market induced adjustments in the exchange rate, and by fall in the international oil prices, he added. He said that a significant source of M2 slackness has been the fall off in private sector credit demand, for both demand and supply reasons, as we will see later. Total private credit growth for the last 9 months has been only Rs 48 billion, versus Rs 345 billion for this period last year. As a result banks have built up considerable excess liquidity, some Rs 410 billion or about 10pc above their reserve requirements, he added. 'This has allowed comfortable accommodation of govt rollover of maturing bills, Rs 1475 billion being bid against Rs 700 billion accepted bills, he added. He said last month has seen a little tightness in rates, with 6-month KIBOR and 6-month T Bills both moving up about 66 bps and 108 bps, respectively. 'Much of this tightness emanated from the auction coinciding with the substantial tax payments to govt at quarter-end March, and is expected to be temporary, he added. He pointed out that despite substantial improvement in the outlook of many important economic indicators, sustainable medium-term recovery remains a challenge. He said that there are structural issues with respect to business conditions that need to be tackled. 'As monetary partners in the overall objectives of the economy, we remain committed to playing our role in aiming to provide both the price stability and the essential liquidity that Pakistans economy requires for sustainable growth, he added. The core inflation is still over 18.5 percent but we hope inflation will decrease to 14 percent in the next three months, Raza said.