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Yahoo! My Yahoo! Mail More Yahoo! Services Account Options New User? Sign Up Sign In Help Yahoo! Search web search Home Singapore Asia Pacific World Business Entertainment Sports Technology Weekend Edition Singapore Asia Pacific World Q+A-Pakistan's double-digit inflation and policy responses Reuters - Friday, January 28 Send IM Story Print By Sahar Ahmed KARACHI, Jan 27 - Pakistan's central bank is expected by most analysts to raise its policy rate by 50 basis points to 14.5 percent on Saturday, which would be its fourth consecutive increase for the fiscal year ending in June 2011. Consumer inflation, in double digits for more than a year, has barely retreated from a 17-month high of 15.7 percent struck in September, despite the policy tightening. Here are some questions and answers about the country's inflation and policy responses: WHAT ARE MARKET EXPECTATIONS? A Reuters poll found 8 out of 10 analysts expect the central bank to increase its key policy rate by at least 50 basis points to 14.5 percent because of high government borrowing following delays in tax reforms, lack of foreign inflows and higher international commodity prices. Analysts said the central bank was unlikely to loosen its monetary policy in the coming months, although how far it would tighten depended on whether it received international funding and on global commodity prices. HOW SERIOUS A THREAT IS INFLATION? Very. Annual inflation in December rose to 15.46 percent even though the monthly pace of price rises fell to 0.51 percent and is likely to fall further due to the base effect. The biggest rises over the past few months have been food prices. The government has further aggravated the problem through its heavy borrowings from the central bank, which the State Bank of Pakistan subsequently funds by printing money. Real interest rates are still marginally negative but analysts said that could change as January's inflation is expected to be lower due to the base effect. HOW DOES GOVERNMENT BORROWING MATTER? Because of the vicious cycle the heavy borrowing spawns. The government has been unable to broaden its tax-to-GDP ratio, currently around 10 percent and one of the lowest in the world. It eliminated food and fuel subsidies, but still has subsidies on electricity which it is unable to eliminate because of political pressure. The International Monetary Fund has asked Pakistan to implement a reformed general sales tax, another measure to broaden its tax base, before it can release the sixth tranche of an $11 billion loan programme that the country turned to in November 2008. This month, the government also reversed its decision to increase local fuel prices due to political pressure, which is going to cut into its revenue. If local fuel prices are kept unchanged and international oil prices keep rising, then the government would eventually have to subsidise fuel and borrow more money from the central bank. The government has borrowed nearly 120 billion rupees ($1.39 billion) from the central bank from July 1 to Jan. 15, compared with the same period of the previous year when it was a net creditor. This increases money supply and fuels inflation. Government borrowing from commercial banks has also increased substantially to around 217.5 billion rupees ($2.53 billion) from July 1 to Jan. 15, 27 percent higher than in the same period last year. Without any rise in the government's revenue, analysts expect the 2010/11 budget deficit is likely to be more than 7 percent of GDP, compared with a target of 4.5 percent agreed with the IMF. The budget deficit for six months ending Dec. 31 was 3 percent of GDP. WHAT CAN THE CENTRAL BANK DO? According to some analysts, the previous three consecutive rate rises sought to discourage government borrowing, but they proved ineffective in weaning Islamabad off the central bank. Given the futility of further policy tightening, analysts reckon the State Bank of Pakistan would rather give priority to economic growth by keeping the key policy rate unchanged. The balance of payments position is favourable and the current account posted a surplus of $26 million for the July-December period. The sluggishness of the manufacturing sector, which indicates a lack of private sector demand, has also given the State Bank a reason to lean towards a looser policy stance. Large scale manufacturing fell 2.3 percent in July-November of fiscal year 2010/11 from a year ago. WHAT OTHER TOOLS DO THE BANK AND GOVERNMENT HAVE? The SBP has been encouraging remittances from overseas Pakistanis, a move which has slowed the pace at which the rupee was falling and helped improve the current account gap. The rupee weakened by 22 percent against the dollar in 2008, a further 6 percent in 2009 and only 1.53 percent in 2010. Export growth has been robust and, along with a rise in remittances, has contributed to a surplus in the current account balance. Besides raising rates, the SBP could raise statutory reserves for banks, but it appears loath to do so because of the burden government borrowing is placing on the banking system, causing yields to rise. Six-month bill yields are above 13 percent. The statutory limit requirement and the cash reserve requirement together force banks to lock up 23 percent of their cash with the central bank. The government, on the other hand, could technically either increase subsidies on food or fuel or increase its revenues by raising taxes, but the ruling coalition has struggled to win backing among its own members for anything remotely unpopular with voters. The government spent 75 to 80 billion rupees in last fiscal year on electricity subsidies. (If you have a query or comment about this story, send an e-mail to news.feedback.asia@thomsonreuters.com) Recommend Send IM Story Print Related Articles Wi-LAN settles with Motorola units Reuters - 31 minutes ago DAVOS-UPDATE 1-China to open up yuan cautiously, boost trade Reuters - 35 minutes ago Gene protects US blacks from heart disease - study Reuters - 36 minutes ago CORRECTED-ADR Report-Japanese ADRs undeterred by rating cut Reuters - 45 minutes ago Audi says China unit sales of 280,000 possible -TV Reuters - 54 minutes ago News Search Top Stories Egypt activists keep up the heat, boosted by ElBaradei 'Thunder-snow' storm buries US north-east Sarkozy: 'Merkel and I will never let the euro fail' Rosneft, Exxon ink Black Sea exploration deal Baghdad car bomb kills 37 mourners More Top Stories » ADVERTISEMENT Most Popular Most Viewed Bad eating can give you depression: study Cruz, Bardem baby boy 'doing great': spokeswoman Marooned Miami bay piano strikes odd note T. rex still king, says dino study Rare Sumatran tiger gives birth to three cubs More Most Viewed » More Most Recommended » Elsewhere on Yahoo! 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