The State Bank announced on Friday another cut in the policy interest rate by 50 basis points to 10 per cent.
In August, the SBP had, in a surprise move, reduced the interest rate by 150 basis points amid an improved inflation projection for 2012-13 and for encouraging private investment.
The move set the trend for future cuts.
Since July the SBP has reduced the rate by 400 basis points.
The monetary policy (October-November) announced on Friday was based on inflationary trend with an assumption that the year’s target of single-digit inflation would be achieved.
“A consistent deceleration in inflation since May to 8.8 per cent in September 2012 is more than earlier estimates. The likelihood of meeting the 9.5 per cent inflation target for FY13 has increased,” said the policy statement.
However, the State Bank expressed serious concern over massive government borrowings from scheduled banks and over the role of banks in the economy.
High inflation made the money costlier for the private sector while banks chose easy way to earn profits by investing in government papers. The private sector is now practically out of banking money.
“The year-on-year growth in loans to private sector businesses has declined from 22.4 per cent in FY08 to 0.7 per cent by the end of FY12,” the SBP said, adding that a declining interest rate environment should lead to a rethink of this strategy.
“Scheduled banks will have to step up efforts to go back to their basic intermediary role and channel loanable funds to the private sector. The resumption of monetary easing, in this environment, was deemed necessary to influence the behavior of borrowers in the private sector and scheduled banks to step up efforts to improve their intermediary role,” said the SBP. However, it said the effectiveness of SBP’s current monetary policy stance continued to weigh upon improvement in the fiscal position, better availability of energy and an increase in foreign financial inflows.
The State Bank urged the government to launch comprehensive fiscal reforms without any delay because these would keep borrowings from the apex bank under check and avoid negative consequences of excessive borrowings from scheduled banks.
“A reduction in the size of fiscal deficit and thus the need for substantial borrowings will also influence the behavior of scheduled banks. At the moment, scheduled banks are finding it easy to avoid the private sector by lending to the government without any risk,” the policy paper said.
It also analysed the inflationary trend and said the disaggregate CPI inflation data showed that this could be the beginning of a broad-based trend. The number of commodities with double-digit year-on-year inflation slightly came down over the past few months after a secular increase over the last three years — first in the food group and then in the non-food group.
The decline in trimmed core inflation measure from 20 to 10.4 per cent in September is slower than the fall in CPI inflation.
“This indicates persistence of inflation expectations due to inertial effect of high inflation experienced in the recent past, the overall rising trend in fiscal borrowings from the SBP and depreciation of exchange rate,” the policy paper said.