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The Economy of Pakistan

Monetary Policy

Group Members

Ali Akram
Hammad Naeem Abdul Mateen Khan

(BBA-FA10-007) (BBA-FA10-028)

Table Content
Monetary Policy Objectives or Goals Credit Control

Quantitative Controls Qualitative Controls

Limitations on Credit Control Policies Monetary policy in Pakistan (1947-57) Changes in Monetary Policy (1958-69).

Table Content
Policy Changes (1970-77) Money and Credit Policy`s Measures during Fiscal Year 2002. Export finance scheme State Bank of Pakistan as Controller of Credit Microfinance bank for poverty alleviation State Bank Of Pakistan`s Monetary Policy Statement 2012

Monetary Policy

It is a branch of economic policy which is concerned with the regulations of availability (supply), the cost and the directions of credit. The actions of a central bank or the currency board that determine the size and rate of growth of the money supply, which in turn affects interest rates.

Objectives or Goals
The objectives of credit control or monetary policy have been different at different time in different countries depending on the economy situations and the problems faced by them. E.g.
Before the First World War maintenance of the exchange rate stability was the main objective. After this war control on inflation become more significance.

Objectives or Goals (Continue)

In modern time, economic development with monetary stability is accepted as the most important goal for credit control in Pakistan. The main objective of this credit control is to save the economy from inflation and deflation and stabilize the economy and prices. Credit control:A strategy employed by manufacturers and retailers to promote good credit among the creditworthy and deny it to delinquent borrowers.

Credit Control
Credit Control divided into two classes Quantitative Controls Qualitative Controls

Quantitative Controls
Quantitative Controls are used to
contract or expand the total quantity of credit.

Quantitative Controls includes: Bank Rate Policy Open-Market Operations Variables Reserve Ratios Liquidity Ratios Credit Rationing Selective Credit Control

Bank Rate Policy

Bank rate policy is varying the rate of interest at which the central bank grants credit to other banks through loans and other eligible securities.
When central bank rate increases, the interest rate also move up When central bank rate is decreases the other banks rates are also move down. Borrowing from banks is encourage so the rate of monetary expansion increases.

Open-Market Operations
The buying and selling of government securities by the central bank with a view to influence money supply is called Open-Market Operations. Variables Reserve Ratios The amount of money which the banks are legally required to keep with the central bank is termed as legal cash reserve ratio or requirement.

Liquidity Ratios
Liquidity ratio refers to the amount of assets which banks are legally required to hold in the form of: Cash in hand Balances with SBP Approved securities.

Credit Rationing
The limit applied on overall credit extended (by each commercial bank), prescribe by central bank is called credit rationing.

Selective Credit Control

It may take many forms: Max Limit: is a limit set on maximum amount extend to borrowers. Selective bans: The grant of credit for certain nonessential purposes may be totally banned. Mandatory targets: are given to commercial banks for preferred sector of economy or borrowers. Cost of finance: may increase or decrease to encourage or discourage investment. Margin requirements: the minimum margin requirement on securities may be relaxed to encourage and tighten to discourage the financing of certain business

Qualitative control
These include: Moral suasion Method of publicity Margin securities rates

Moral suasion
Central bank can persuade the commercial banks to follow a specific pattern of credit policy. The central bank can employ oral or written appeals or warnings.

The central bank can give publicity to desirable credit policy through its different publications. Banks can take guidance from this in respect of their lending and financing operations.

Margin in securities rates

Variable margin is prescribed for securities purchases quoted on stock exchanges. OR A type of security that may be purchased or sold using a margin account.

Limitations on Credit Control Policies

There are several difficulties faced by the central bank to control credit:

Absence of developed money market:In underdeveloped countries , the central banks control over bank credit is rendered very difficult by the absence of well developed money markets.

Existence of non-monetized sector (produce just only to satisfy their own needs):Due to existence of non-monetized sector a big section of community is quite unaffected by any monetary policy.

Large scale deficit financing (expenditures increases w.r.t revenue):Due to deficit financing central bank is powerless in controlling the amount of credit and inflationary pressures.

Cooperation's of bank:It is very difficult for central bank to control credit if commercial banks do not cooperate.

Conflicting objectives:The greatest difficulty faces by the central bank is conflicting objective. E.g. the confliction of Price Stability and Economic Development. Increase in one objective tends to decrease in other objective.

Conventional techniques:The conventional techniques like bank rate policy, open market operation and effective reserve ratio are very effective in developed countries like US and UK. But in pakistan they are very limited.

Credit ceiling:The highest amount that a lender will allow somebody to borrow. To apply ceiling level which are practical and effective at the same time is very difficult.

Selective control:-

The first problem is that it is difficult to control the ultimate use of finance by the borrowers. Secondly there is the problem of satisfactory supervision and ensuring proper response from each bank. In short the selective control system is very difficult task.

Monetary policy in Pakistan (1947-57)

Monetary policy in Pakistan (1947-57)

The state bank of Pakistan from 1947 to 1958 could not achieve the above desired goals of the monetary policy due to various reasons : 1.Due to low domestic savings: The governments had to resort to deficit financing and external borrowing for increase the level of investment . Foreign loans and deficit financing increase inflationary pressure in the country. 2.Capital market : There was no organized money and capital market in the country . The state bank , therefore had no effective control over them

Market mechanism: The monetary policy in the absence of market mechanism remained almost ineffective . In the first two decades the economy was in a weak position by a number of economic controls such as a price control , rationing etc. Fiscal policy and monetary policy: There was a little coordination between the fiscal policy and monetary policy . such the monetary policy was unsuccessful in regulating the money and credit supply in the country .

Changes in Monetary Policy (1958-69).

There were some changes in monetary policy in 1958_69. During 1958-69 , the government granted moderate concession to the private in the country . Five years plan (1955_60) the monetary expansion amounted to Rs.195.69crore . In second five year plan(1960-65). the money supply increased by RS.280.84crore . Bank credit both in private and public sector increased to RS.161.74corers in first years plan .and in second year plan it was equal to RS.477.03crore.

Export bonus: The government introduced the export bonus scheme in january1959 for increasing exports and improving balance of payments position . The scheme was introduced in 1962 to protect the interests of the exporters against commercial and political risks. The liquidity ratio of commercial banks was raised from 20 % to 25% in 1967.

Policy Changes (1970-77)


governments made huge reduction of the rupee by 131% in may 1972. The export scheme was discarded in 1972 . The liquidity ratio of commercial banks was raised from 25% to 30% in june1972 There was a rapid expansion in the monetary assets from 1970 to 77. they increased from RS.21,234.4 million to RS.5767.2 million by december1977. The state bank fixed credit ceiling and working capital for private and public sectors . these credit ceilings exercised effective limitation on the under expansion of credit .

The Annual report of 2001 to 2002 was attached with the state bank of Pakistan contains money and credit policy measures for fiscal years 2002. These measures are : Money market measures: Habib Bank limited ,national Bank of Pakistan , Union Bank limited , City Bank, A, American Express Bank and Standard chartered Bank were reappointed as primary dealers for FYO2 .These decision was made on 18 june2001.

Money and Credit Policy Measures during Fiscal Year 2002.

With effect from 25 july2001.the state Bank of Pakistan decided to conduct OMIs and when required by market conditions, giving previous hints to banks Liquidity control measures: On 19 july 2002,it was decided to reduces the discount rate from 14.0% to 13.0% .This rate was further reduced to 12.0% on 16August 2002.On 20october 2002 the discount rate was again reduced by 2% point to 10%and then 1%point to 9%with effect from 23 januray.

Export finance scheme

Effective from 1july 2002, the maximum rate of finance charged by banks from their borrowers under the export finance schemes for all eligible commodities and export sales under (LMM) was raised from 10.5 to 13% per annum . The SBP refinance rate was raised from 9%to 11% however these rates was later reduced by 1% on october2001. The State Bank of Pakistan introduce new method according to the part 1 of the export schemes was that all dealing should be in written form . Exporters of bleach/unbleached clothes were provided financing facilities under_1of EFS .This provision was however, made conditional to

The exporter finance facility was extend to the export of bones under both parts of the schemes. The export of wheat under 1 at post shipment stages to the private sector only.
The export of brown rice to the European countries effective from 13april the existing facility for exporting brown rice in packing of 1-50 kg.

It was decided the rate of refinance under the export refinance schemes would remain at 6.5 % for the month of may .

State Bank of Pakistan as Controller of Credit

State Bank of Pakistan as Controller of Credit

1. Objectives of Credit Control.
The State Bank of Pakistan Act 1956 gives special powers to the State Bank to control the volume and direction of bank loans in the country. The credit policy follow by the State Bank aims at channelizing funds of the commercial banks to useful sectors of the economy. It discourage the use of bank loans for nonproductive purposes so as to achieve wealth, stability and the growth of domestic economy

2. Instruments of Credit Control:The principal weapons which have been used for controlling the volume and direction of bank credit in the country are almost the same which are being applied in other countries of the world by their central banks. The main instruments of credit policy applied by the State Bank of Pakistan are now discussed in brief.

(a) Quantitative Control.

A government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. It consist of :Bank Rate: Bank rate is also called the discount rate. Bank rate is the official rate at which the State Bank rediscounts the first class securities at its counter. The State Bank raises or lowers the discount rate from time to time in accordance with the credit requirements of the Country.


2. Open Market Operations. The buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system. Purchases inject money into the banking system and stimulate growth while sales of securities do the opposite. To increase the money supply, the central bank buys securities from commercial bank and public.

3. Variable Reserve Requirements. The amount of money which the banks are legally required to keep with the central bank is termed as legal cash reserve ratio or requirement. The state bank of Pakistan , under section 36 of the act required the scheduled bank to maintain at least 5% of the demand and time liabilities with them .

4. Credit Rationing Central bank can issue directions Loans will be given to commercial banks up to a certain limit Commercial banks will be careful in advancing loans .

5. Credit target:The Government of Pakistan set up National Credit Consultative Council (NCCC) in 1974. The functions of NCCC is to examine overall credit situation in the country and indicate the credit limits for the public and private enterprises. The State Bank of Pakistan sets specific target of funds to be given to agriculture business industry and low cost housing by the commercial banks. If the commercial banks fail to achieve the ceilings, it imposes penalty on them. The defaulting commercial banks shall have to make interest free loan to the State Bank of the amount falling short of the target.

(B) Qualitative Controls.


Moral Persuasion.
If the commercial banks are advancing funds for non essential activities, the State Bank can influence and directly appeal to them to follow the monetary rules and regulations laid down by the Bank.

2. Direct Action.
If the commercial banks do not act upon the credit policy of the State Bank, it is then empowered to take action against them.

Microfinance bank for poverty alleviation

On 12 august 2000, the government announced the establishing of a microfinance bank to lend credit to millions of poor people . To undertake the management, control and supervision of any organization , enterprise , scheme, trust funds for the benefit and advancement of poor person To carry out survey and research , and to issue publication and maintains statistic related to the improvement of economic condition of poor person


To encourage investment in cottage

industries and income generating projects the poor people

State Bank Of Pakistan`s Monetary Policy Statement 2012

State Bank Of Pakistan`s Monetary Policy Statement 2012

The conduct of monetary policy in Pakistan has undergone a exemplar shift in the result of financial sector reforms that were initiated in the late 1980,s. In early period, monetary policy relied on direct instruments e.g. credit restrictions on individual banks. Currently, it is conducted through the market based mechanism, and indirect instruments like discount rate and open market operations to impact inter-bank liquidity.

The economy seems to have settled at an undesirable equilibrium of high inflation and low growth. The extended energy crisis and weak fiscal fundamentals are the main reasons behind this outcome. Similarly, the declining trend in private investment expenditures is continuing while strength of the balance of payment position remains contingent upon foreign financial inflows.

In this forced environment the impact of monetary policy has become limited; whether it is in terms of direct effects of interest rate changes or broad influence on expectations in the economy. Nevertheless, the State Bank of Pakistan will continue to play its required role in pushing the macroeconomic outcomes. For instance, there has been some deceleration in inflation, which has improved its outlook.

Inflation Trend

The average CPI inflation for FY12, 11 percent, was well within the target of 12 percent for the year. The main reason for this moderation in inflation is a collapse in real private investment, indicating a structurally weak economy. It seems that key drivers for this expectation are continued fiscal borrowings from the SBP despite legal restrictions and feared depreciation of exchange rate even with a modest external current account deficit.


SBP projects average CPI inflation for FY13 to remain in the range of 10 to 11 percent, which is higher than the announced target of 9.5 percent for FY13. However, much would depend on fiscal restraint on borrowings from SBP, realization of estimated foreign financial inflows, and improvement in energy shortages to increase the utilization of installed capacity.


SBP projects average CPI inflation for FY13 to remain in the range of 10 to 11 percent, which is higher than the announced target of 9.5 percent for FY13. However, much would depend on fiscal restraint on borrowings from SBP, realization of estimated foreign financial inflows, and improvement in energy shortages to increase the utilization of installed capacity.

The decline in CPI inflation is considerably faster than earlier estimates. The year-on-year CPI inflation for November 2012 stands at 6.9 percent, with food inflation dropping to 5.3 percent and non-food inflation coming down to 8.1 percent. Therefore, the Central Board of Directors of SBP has decided to reduce the policy rate by 50 basis points to 9.5 percent with effect from 17 December 2012

Interest rate
Led by direct and portfolio investment flows, the total net capital and financial account inflows are on a declining path for some years now. For instance, these inflows have come down from a peak of 7.2 percent of GDP in FY07 to 0.7 percent of GDP in FY12. This trend is continuing in FY13. During the first four months, there has been a net outflow of $304 million from the capital and financial account.

This, together with important debt repayments to the IMF, has resulted in a decline in foreign exchange reserves of SBP from $10.8 billion at end-June 2012 to $8.6 billion as on 14 December 2012. Since the beginning of FY13, the rupee, viz-a-viz dollar, has depreciated by 3.3 percent.

the decline in foreign exchange reserves is causing contraction in rupee liquidity. A depreciating currency is also affecting the size of the outstanding external debt in rupee terms and thus has implications for the fiscal position.

Both the level of interest rate set by the SBP and the timely realization of budgeted foreign inflows are critical in managing the balance of payment position. The lower interest rate can potentially affect the credit demand, including that of imports, and return on rupee denominated assets relative to foreign currency assets.


The utilization of credit by private businesses is one of the important ingredients of investment. However, the net flow of credit to Private Sector Businesses (PSB) was a meager Rs18.3 billion in FY12, which is a drastic decline compared to a net flow of Rs173.2 billion in FY11. The main factors that have significantly dampened the demand for credit by private sector businesses are persistent electricity and gas shortages, security conditions, and a challenging political environment

In conclusion, improvement in key economic indicators would require comprehensive and credible reforms in the energy and fiscal sectors. Adherence to the legal framework(s) of economic policy making The State Bank of Pakistan Act (1956) and The Fiscal Responsibility and Debt Limitation (FRDL) Act (2005) is important as well. A drive for economic reform and adherence to laws can go a long way in moving the economy towards a better equilibrium with low and stable inflation and high and sustainable growth.

Among all these developments, two factors are particularly important inflation outlook has improved with a projection of 10.5 percent for FY13 and loans to private sector businesses have sharply decreased. This has led to an increase in real interest rates. In taking the monetary policy decision, the Central Board of Directors of SBP has decided to give a relatively higher weight to the state of private sector credit and investment in the economy, knowing that the projected inflation for FY13 could remain slightly higher than the target.

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