KARACHI - State Bank of Pakistan on Tuesday raised its benchmark interest rates by one per cent, the third such move since January to fight galloping inflation and to stop alarming government borrowing. The SBP announced Monetary Policy for the first half of FY09, which will be effective from July 30 (today). The Cash Reserves Requirement (CRR) and Statuary Reserves Requirement (SRR) remained unchanged. The Bank raised the interest rate at which it lends to commercial banks to 13 per cent from 12 per cent. "Our inflation is reaching alarming levels mainly due to borrowing," said SBP Governor Shamshad Akhtar while announcing the Monetary Policy. Shamshad said raising the rate to 13 per cent would help in curbing rampant government demand as borrowing had doubled in six months, constituting 80 per cent of the entire fiscal deficit that was equivalent to 8.3 per cent of the GDP. The Governor lambasted the country's newly-elected fractured parliamentary coalition government for its unbridled appetite for asking the bank to print more money, further fuelling inflation. Shamshad said the government had borrowed 204 billion rupees between January and March and 283.9 billion from April to June. In the last two days alone, it borrowed 55 billion rupees, she added. "For the first time the entire board of directors of the central bank will pass a strong resolution to ask the government to stop its borrowing," Shamshad said. The continuous internal and external pressures have already caused an erosion of the central bank foreign exchange reserves by 6.5 billion dollars to just 17 weeks of import against 31 weeks six months ago. Shamshad said the country's food inflation had already reached an all-time high of 32 per cent while the overall core inflation was also sitting on a 30-year high. "Inflationary pressures are more alarming than ever before," she said and added "Global crude and commodity prices have induced recessionary trends in global economies. Pakistan is no exception." "Govt borrowing is totally unsustainable," Shamshad said. "It had never reached the level it has reached today." The central bank has advised the government to retire 21 billion rupees of debt every quarter this fiscal year, she said. The budget deficit widened to 8.3pc of GDP in the 12 months to June 30, the central bank said. That's the highest since 1991 when it reached 8.8pc, according to finance ministry website. Pakistan's first civilian govt since a 1999 military coup says it wants to narrow the gap to 4.7 percent of GDP next fiscal year. That target 'has already come under stress', Shamshad said. "The government tends to underestimate expenditures and overestimate revenue," she added. The current 2009/2010 fiscal year need to be one of 'consolidation and containment', Akhtar said. Aside from the fiscal deficit, Pakistan is also faced with a widening current account deficit, dwindling foreign exchange reserves and inflation at a three-decade high, running over 21 percent and likely to worsen. The central bank left banks' cash reserve ratio at 9.0 per cent and statutory liquidity requirement at 19.0 per cent. Considering the adverse impact of continued borrowing by the government from SBP on inflation, the SBP Central Board of Directors resolved that government should retire Rs21 billion in each quarter of FY09. Shamshad said that considering the risk related to rising external current account and fiscal deficits and worsening inflation outlook, the central bank was urged to maintain its tight policy stance. She said that the SBP fiscal coordination with the monetary policy stance was formulated in particular commitment to scale down government borrowings from the central bank and to contain import growth which was critical to achieve the desired impact of monetary tightening.   She said in July 07, SBP policy rate was raised by 50 bps to 10 per cent simply to allow for sterilisation of excessive inflows, which came in the last two weeks of FY07, and stem anticipated inflationary pressures. However, in January 2008, viewing the developments in H1-FY08 and outlook for future, SBP advocated the need for strengthening demand management and raised policy rate by another 50 bps to 10.5 percent. Recognising the scale and magnitude of unprecedented economy-wide pressures and urgency of the situation, SBP introduced a host of emergency interim monetary policy measures in May 2008 to restore macroeconomic stability. Analysing the outcome of FY08, she termed growing external current account deficit, low financial inflows which met CAD only partially and pressures on foreign exchange reserves straining exchange markets were most imminent challenges to macroeconomic stability. She said to restore macroeconomic stability there is need for additional corrective policy actions, both at the government and central bank level. Assuming the domestic demand continues to grow at last five year's average of 8.1 per cent and the real GDP growth target of 5.5 per cent for FY09 is achieved, the difference between domestic demand and supply is expected to widen further. To curtail aggregate demand pressures through restraining expenditures in the short run; government should increase the production capacity of the economy by addressing structural constraints; and to improve factor productivity. These measures are necessary for ensuring price stability and long term growth on sustainable basis. While it is expected that some of the demand pressures will recede in the current fiscal year, but if the supply side issues are not addressed, the 'gap' could remain unchanged and the expected favourable impact on inflation will be diluted. She said the difference between the real domestic aggregate demand and supply of goods and services in the economy widened during FY08 and the rise in both the external current account deficit and the fiscal deficit are only a manifestation of this gap. The growth in real domestic demand (7.1 percent) was stronger than in real supply (5.8 per cent) and was mainly driven by a sharp rise in real consumption expenditures (both private and government) in the economy; the growth in real investment expenditures remained subdued (3.4 per cent). The rise in consumption expenditures also reflect a deceleration in national savings and therefore broadening of the saving investment gap in the economy. The widening of the external current account deficit is a mirror image of this difference and requires inflow of foreign savings in the country. The unsustainability of this saving investment gap is evident from the current levels of both the external current account deficit and the trends in real domestic aggregate demand and supply growth.   Giving the economic outlook for FY09, she stated the FY09 ought to be a year of consolidation. Therefore, recognizing this, the government and the central bank have taken pre-emptive policy actions together. Budget deficit for FY09 has been rolled back to 4.7 per cent of GDP and government has committed itself to achieve net zero borrowing from SBP during the course of the year, while enhancing its reliance on other non-bank sources. To reinforce further, on 10 June 2008 (ahead of the budget for FY09), SBP advised the government that the Central Board of Directors recommend net retirement of Rs84 billion for FY09 with quarterly retirement of Rs21 billion. These limits have been worked out keeping in perspective the need for consistency with a coherent macroeconomic framework. Adhering to these commitments and targets will be vital to arrest the drift in macroeconomic imbalances. Imposing hard budgetary constraints further requires that the government amends the Fiscal Responsibility and Debt Limitation Act, 2005 to include provisions for recognising the need to phase out the government's dependence on SBP borrowings over a period. This involves adherence to limits imposed on SBP borrowings henceforth, while lowering the stock of SBP borrowings. She further said that fiscal framework for FY09 will need to be dynamic to incorporate necessary adjustments as economic developments evolve. She said budget outcome for FY08 revealed gross underestimation in several heads of recurrent expenditures including interest payments and excessive subsidisation of oil and food products that grew from Rs114 billion budgeted level to Rs407 billion as the government opted to delay the pass through of prices. Consequently, fiscal deficit grew unabatedly without due regard to the resource envelope. Rise in fiscal deficit and inability of the government to tap non-bank and external resources over and above the projected levels resulted in excessive recourse to central bank's borrowings. She also stated the impact of this excess liquidity is serious for inflation outlook, as this has added to the currency in circulation and diluted the tight monetary policy stance. Efforts to offload government borrowings to the market are already exerting further pressure on Karachi Inter-Bank Offer rate and other market interest rates. In fact, the market has already raised its bid prices in T-bill auctions and consequently the 3-month cut-off rate has peaked to 11.8 per cent reaching close to SBP's policy rate of 12 per cent. Early indications are that the budget deficit target for FY09 of 4.7 percent of GDP is already coming under stress. Aside from the changing oil and exchange rate scenario relative to budgetary assumptions, SBP assessment is that the budget underestimates spending and overestimates revenues. Containing expenditure growth at 6.5 percent, given a track record of 20.3 percent average increase during the last five years, seems difficult and the subsidy bill is likely to come under strain unless political pressures are muted. Similarly, realizing the estimated growth in tax revenue at 24 percent seems challenging given the average growth of only 12.8 percent during the last 5 years.  It must be kept in view that past few years benefited from the high and fairly robust GDP growth (7.0 percent on average); while for the coming year a growth of only 5.5 percent is being anticipated. She said the balance of payment scenario for FY09 demands further policy action. Curtailing import growth and raising the exports further are critical for narrowing the external current account deficit which is key to the macroeconomic sustainability. Additional efforts to mobilise financing to meet the external current account deficit is equally critical as the assumptions underlying balance of payment projections have changed with the rise in international oil prices. At the same time financing mobilisation will need to be calibrated to restore foreign exchange reserves to a more comfortable level.