Pak banks on interest rates to manage demand pressure

KARACHI: Pakistan’s central bank governor Shamshad Akhtar said higher consumption spurred by salary increases and food subsidies in the June 9 budget will have to be managed through interest-rate policy.

“You need appropriate interest rates to manage demand pressures effectively,” Akhtar said in an interview on Wednesday in Karachi. “Demand pressures will continue and will have to be diffused by monetary policy,” as “we have to promote economic growth and maintain price stability at the same time.”

Pakistan’s government raised wages and pensions by as much as 20% in its budget and increased subsidies on basic foods including lentils, tea and cooking oil, aiming to allay voter concerns about inflation. Prime Minister Shaukat Aziz faces re-election in January with consumer prices rising at three times the pace they were before the previous poll in 2002.

“There will be price pressure which could be quite significant,” said Sakib Sherani, chief economist at ABN Amro Holding in Islamabad. “I don’t think the central bank will raise rates because they’re pretty content with the current trajectory of inflation and aggregate demand.”

Bonds were unchanged and the rupee fell. The yield on Pakistan’s 10-year benchmark 9.6% bond was 10.13% as of 12.10 pm in the secondary market in Karachi. The rupee declined to 60.63 to the US dollar from 60.61 on Wednesday.

The central bank is due to release its monetary policy statement in July. Rising prices prompted the State Bank of Pakistan in July 2006 to lift its key interest rate half a percentage point to 9.5%, the first increase in 15 months.

Consumer prices in South Asia’s second-largest economy rose 7.41% in May from a year ago, following a gain of 6.92% in April. Food inflation, which has a 40% weight in the consumer price index, increased 11% last month. “Food price issues are management issues,” Akhtar said. “Surpluses and shortages need to be managed with a better distribution mechanism by the government.”

Inflation for the year ending June 30 is likely to miss its 6.5% target and fall within a revised range of 7.5% to 7.8%, the central bank said in its quarterly report on the economy on May 26.

Shoddy roads, markets and other infrastructure make it harder for farmers to get their produce to Pakistan’s cities, where about 40% of the nation’s 160 million people live. Finance Adviser Salman Shah said a government spending plan that raised wages and subsidies for food and fertiliser was “an election year” budget.

“On the one hand it is a populist budget but on the other it’s the need of the day,” said Akhtar. “With the way food prices have been, it was critical to compensate people for inflation.” Pakistan’s national elections are scheduled by January 15, 2008, as parliament completes its five-year term in November.

Inflation in Pakistan peaked at 9.3% in 2005 and “remained high” at 7.9% in the following 12-month period as increased investment and rising remittances from nationals living abroad stoked consumer price gains, the Asian Development Bank said in a March 27 report.

“We have had an effective demand management policy,” Akhtar said. “We have withstood all pressures to not lower interest rates and we will continue to withstand any pressures to prematurely adjust interest rates downwards.”

Junior finance minister Omar Ayub Khan said in his budget speech Pakistan will increase development spending by 25% to 520 billion rupees ($8.6 billion) in the year starting July 1 to ensure poor infrastructure doesn’t derail growth.

“Our competitiveness is being hurt by weak infrastructure and weak human capacity,” Akhtar said. “Interest rates have a smaller impact on the cost of doing business than infrastructure constraints.”

The government is targeting record $6.5 billion foreign investment in the fiscal year ending June 30 to spur economic growth to 7.2% from 7%, Khan said on June 9. Pakistan needs political stability to ensure overseas investors join Standard Chartered, China Mobile, and Emaar Properties and sustain economic growth that averaged 7.5% in four years.

``Economic developments are not getting infected by political circumstances,’’ Akhtar said. ``A prerequisite for foreign investment to continue will be political stability.’’

Protests against President Pervez Musharraf have worsened since he removed Chief Justice Iftikhar Muhammed Chaudhry on March 9 for allegedly misusing his authority. Musharraf will seek a new five-year term as president before parliament ends on Nov. 15, while also retaining his post as the army’s chief.

``At the highest level, we’re committed to facilitate foreign investment because we recognise there may still be roadblocks in the system,’’ Akhtar said. Pakistan is ``hugely preferable’’ to foreign investors compared with other nations in the region as ``we are more transparent and less complicated.’’

Pakistan is competing with its neighbours for investments with regulations that allow full foreign ownership, free movement of capital and unrestricted repatriation of profits.

``Investors focus on the fact that much more of our market is open than many neighbouring countries and we have access to senior levels of government,’’ said Zubyr Soomro, president of the 169-member Overseas Investors Chamber of Commerce and Industry in Karachi. Soomro heads Citigroup Inc.’s Pakistan operations.