Pakistan in surprise rate rise, cites inflation risk

Pakistan's central bank unexpectedly increased its key policy rate by 50 basis points to 13% on Friday as inflation and fiscal weakness is overshadowing improvement in the current account deficit and economic growth.

The central bank's acting governor Yaseen Anwar said a change in monetary policy was needed to mitigate risks to economic stability.

"Therefore, SBP is increasing the policy rate by 50 basis points to 13 percent with effect from Aug. 2," Anwar said.

In a Reuters poll, 12 of 15 analysts expected the central bank to keep its policy rate unchanged for August and September.

The rate decision came after Pakistan markets had closed but analysts said the move could trigger a drop in shares early on Monday, reversing a 0.9% gain on Friday.

The State Bank of Pakistan (SBP), which meets to discuss monetary policy every two months, kept the rate unchanged at 12.5% on May 24.

Inflation averaged 11.7% in the 2009/10 fiscal year ending in June, 2.7 percentage points higher than the central bank's target and Anwar said current trends and expected developments indicated that inflation risk would continue through the 2010/11 fiscal year.

This is due to a rise in electricity prices, an increase in the general sales tax and a revision in government employees' wages.

Anwar said Pakistan missed its fiscal deficit target of 5.1% for 2009/10 and it could be higher than 6.0%.

Under an IMF programme agreed in November 2008 for a two-year emergency package totalling $10.66 billion, Pakistan's government also agreed to zero net borrowing from the state bank.

According to official data, the government overshot that target by 41.93 billion rupees (USD 490 million) in 2009/10, a cause for concern among economists and analysts.

"Clearly, such developments are inconsistent with the objectives of macroeconomic stability," Anwar said, adding that a deficit target of 4 percent of GDP for the 2010/11 fiscal year already seems challenging. The deficit could exceed 5.0% of GDP, he said.

The central bank also stressed the need to "urgently" increase the tax-to GDP ratio and boost revenue for sustainable economic growth.

Increased government borrowing from the central bank increases money supply, which in turn can fuel inflation.

The IMF said in its country report on Pakistan last month that it had held discussions with the government focusing on the fiscal programme and also "a possible tightening of monetary policy to address the rebound in inflation".