KARACHI- The State Bank of Pakistan (SBP) on Saturday decided to keep its key policy rate unchanged at 14 per cent, fearing that the lack of any coherent strategy from the government to limit growing fiscal slippages could intensify the risk of higher domestic inflation in time to come. The move is unexpectedly even as inflation accelerated to the fastest pace in Asia. SBP Governor Shahid H Kardar, who blamed above-15 per cent inflation rate on government borrowings, said the three rate increases announced since July were 'crowding out investment and curtailing growth. The SBP had jacked up the discount rate by 50 basis points to 14 per cent in December-January monetary policy review of the current financial year 2010-11. It had reported 100bps increase in interest rates from July 30 to November, 29 2010. The central bank had raised the rate by 50bps to 13 per cent on July 30 and announced further 50bps to 13.5 per cent hike in policy rate on September 29. The SBP expressed serious concern over the increasing size of the countrys fiscal deficit, warning that meeting revised target of 4.7 per cent would be a major challenge for the government in the absence of fiscal reforms. The central bank in its latest monetary policy document stated that the deficit had started to touch Rs500 billion by the close of H1-FY11. It says these fiscal developments have two implications. First, the overall demand for money is unlikely to subside, which indicates high aggregate demand relative to current productive activity. A concurrent increase in banking system deposits through a decline in currency in circulation would be helpful in meeting this demand without additional pressure on market interest rates. Second, the private sector is likely to be squeezed out, which is contrary to what the economy needs for the revival of investment and growth. It must be mentioned that at the beginning of the fiscal year, the announced fiscal deficit target was Rs685 billion (4 per cent of GDP) that was revised to Rs812 billion (4.7 per cent of GDP) in the aftermath of the floods. The SBP document further revealed that tax collection of Rs661 billion by the Federal Board of Revenue (FBR) during H1-FY11 showed a growth of 13 per cent only against 26 per cent envisaged at the beginning of the fiscal year to achieve the target of Rs1667 billion for the year. Thus, a shortfall in revenue appears quite likely, especially with the postponement of revenue enhancement measures. At the same time, rising expenditures, primarily owing to subsidies for energy, food items (like wheat and sugar), cash transfers, and security related activities, further indicate difficulties that lie ahead. Kardar, while unveiling the Monetary Policy Statement at a press conference held at the SBP premises, said the bank was also aware of the delicate balance that needed to be struck between risks to inflation and economic growth, and therefore, had decided to keep the policy rate unchanged for the time being. This cautionary policy stance has been using as a trade-off between inflation and growth, he said. According to Kardar, while the underlying structural reasons for the policy stance have not changed significantly, there are three sources of comfort. First, the bank anticipates that the current shift away from the SBP financing will be consolidated since an understanding has been reached with the government that it will restrict its borrowings from the SBP to below the end September stock of Rs1290 billion. Second, an external current account surplus in H1-FY11 is somewhat rare in Pakistan and is a marked improvement over earlier projections. Third, the SBP is optimistic that the recent multi-partisan efforts will improve fiscal revenues and curb current spending (one-off and continuous). Talking about current state of the economy, Kardar said the delays in crucial economic reforms had increased challenges for the management of the economy. Despite high interest rates, the fiscal deficit and borrowings from the banking system was continuing to stoke inflationary pressures, he said, adding that it was impeding economic recovery and increasing the debt burden of the country. However, an improved external current account and stable financial markets allow for some optimism, he said. Under these challenging circumstances, a proactive monetary policy is necessary but not sufficient to tackle high and persistent inflation, Kardar said. He pointed to the inflationary pressures that were already high at the beginning of FY11, and have remained at elevated levels during first half of FY11. The SBP governor said the revised projection of average CPI inflation for FY11 fell in the range of 15 to 16 per cent, along with high probability of double digit inflation in FY12. To bring inflation under better control, the critical measures would be fiscal consolidation and reduction in fiscal deficit and government borrowings from SBP, he said. Kardar urged the federal government to spell out a clear and coherent strategy to limit fiscal slippages. This is all the more important given that the proposed reforms in the GST along with other tax measures have been postponed, said and added that in January 2011, the government also reversed the decision of increasing retail prices of petroleum products. Apart from adversely affecting revenue collections and increasing expenditures on subsidies, these actions have made it difficult to raise external resources for budget financing, he added. He revealed that the external current account showed a surplus of $26 million during H1-FY11, a marked improvement over earlier projections. Robust export earnings of $11.1 billion were the main reason underlying this encouraging development. Higher international prices of Pakistans exports like textiles and rice were helpful in this regard.