MONETARY POLICY

Regulated authority

STATE BANK OF PAKISTAN

SAMEERA DAR
Roll no # 1542

Facts and Figures

Central Bank of: Pakistan Established: 1947 Headquarters: Karachi Governor: Shamshad Akhter Official website: www.sbp.org.pk

Monetary Policy
It is a policy of central bank to control the supply of money with the aim of achieving macro economics stability. (Harry Johnson)

Characteristics
Tool used by the national govt. to influence the economy Controls the supply and availability of money Controls the cost of money (interest) Contrasted with fiscal policy

OBJECTIVES OF MONETRY POLICY

Full Employment Increase in the production Increase in the investment Economic development Stability of Capital Market

Proper Distribution of Wealth Exchange Rate Stability To increase Exports Improvement in standard of living

Price Stability As Basic Objective

Improving the transparency of the price mechanism,

Reducing inflation risk premier in interest rates.

Avoiding unproductive activities to hedge against the negative impact of inflation or deflation.

Reducing distortions of inflation or deflation,

Preventing an arbitrary redistribution of wealth and income as a result of unexpected inflation or deflation.

BENEFITS OF MONITRY POLICY

 Short run- Monetary Policy Transmission Mechanism Long-run Neutrality of Money

Inflation a Monetary Phenomenon

 In practice all types of monetary policy involve modifying the amount of base currency (M0) in circulation. This process of changing the liquidity of base currency through the open sales and purchases of (government-issued) debt and credit instruments is called open market operations.

DIFFERENCE BETWEEN THE VARIOUES TYPES OF MONETARY POLICY

Inflation Targeting
Under this policy approach the target is to keep inflation, under a particular definition such as Consumer Price Index, within a desired range.

Price Level Targeting

Price level targeting is similar to inflation targeting except that CPI growth in one year is offset in subsequent years such that over time the price level on aggregate does not move.

Monetary Aggregates
In the 1980s several countries used an approach based on a constant growth in the money supply. This approach was refined to include different classes of money and credit (M0, M1 etc) This approach is also sometimes called monetarism.

Fixed Exchange Rate

This policy is based on maintaining a fixed exchange rate with a foreign currency. There are varying degrees of fixed exchange rates, which can be ranked in relation to how rigid the fixed exchange rate is with the anchor nation.

MIXED POLICY
In practice a mixed policy approach is most like "inflation targeting". However some consideration is also given to other goals such as economic growth, unemployment and asset bubbles. This type of policy was used by the Federal Reserve in 1998.

SABA KHURSHEED
Roll no # 1541

Risk & Challenges Faced By Monetary policy

2008 has been a difficult year for global economy including Pakistan. it is facing many challenges & risks such as, Turbulent state of international financial market & downgrading paks rating by international organization. Growing global commodities prices, oil & food prices. Growing external a/c deficit. Depreciation of rupee against us doller. Gap b/w demand and supply

Trends Followed By Current Monetary policy

As Pakistan follows tight monetary policy Major trends followed by Pakistan's current monitory policy are, Heavy Govt borrowing from SBP diluted the impact of monitory measures of Jan 2008 The monitory tightening in Jan 2008 helped in draining inter banks liquidity & pushing interest rates up.

Banks lending rates are move up & has risen 12.8% June 2008 from 10.9% recorded in April 2008. Due to inflation real return on deposits decreases 17.8% to13.9% in 2008. Growth sustainability demand, stimulating investment a consumption not for driver of economic growth.

Gap in B.O.P was almost us $5.8 billion.

Reduced foreign exchange reserve increase pressure on F. exchang rate.

Fiscal deficit rose sharply & expended to above 8% of GDP against 4% est target for FY 2008. Govt borrowing from SBP increased & reached at double of Rs 1053billion.

Private sector credit grew by 17.3%& reached Rs 408.4 billion.

Due to change in composition of monetary aggregates NDA Dec from Rs 316.4billion to 274.6 billion

Inflationary pressure in economy increased considerably. At present the risk of inflation overall macro economic stability far greater than the risk to economic growth & needs necessary stabilization measures.

SANA KHALID
Roll No.127

Tools of Monetary Policy

1.Quantitative

Methods

1.Changes in Bank Rate Policy or Rediscount Rate

Rate at which central bank gives loans to commercial banks Central bank charges 10% as bank rate To control inflation central bank increases the rate of interest
2. Open Market Operation

Central bank sells or purchases government securities To remove inflation they sell the government securities Commercial banks will purchase these securities to earn interest

3.Change

in Reserve Requirements

Commercial bank has to keep certain proportion of its deposits in the form of reserves 30% of its deposits to meet the needs of its depositors Commercial banks are advancing excessive loans Central bank Increases the reserve requirements
4.

Changes in Marginal Requirements

Commercial banks do not give loans against leaves They ask for pledges to make Pledge are settled by the central bank. If there is inflation, the marginal requirements will increase by central bank

5. Changes

in Reserve Capital

Commercial bank has to keep 5% of its deposit in the central bank By changing reserve capital, central bank can control the supply of money To remove inflation, they will increase the reserve ratio
6. Credit

Ceiling/Rationing of Credit

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

Qualitative Methods
1.

Moral Suasion
Moral request by central bank to commercial banks Loans should not be given for unproductive fields Loans should not be given for speculative purposes and hoarding

2.

Consumers Credit Control

Applied during inflation If the central bank wants to control the supply of money central bank issue directions to commercial banks Loans should not be advanced for consumption purposes

Concerned with the policy of central bank against commercial banks Central bank will not advance loan to commercial banks for the sectors which create inflation

3.Direct

Action

4.Publicity

Central bank keeps an eye over the activities of the commercial banks If the commercial banks are found advancing loans which create inflation The central bank can black list such banks

SALMA BASHIR
Roll no # 126

Effectiveness of Monetary policy

Accuracy of inflation forecasts - try to reduce inflationary pressures before they occur Interest Elasticity of Demand - measures how responsive demand is to a change in interest rates Levels of Government debt - High levels of government debt generally put upward pressure on interest rates Effects of interest rates not equally shared Inflation expectations

MONETARY POLICY STATEMENT

July December 2008

Monetary Policy Statement

Economic Environment and SBPs Policy Response during H2FY08

Growth rate is expected to slide from 8 percent in 2007 to 6.9 percent in 2008. Strong trends in inflation has emerged for this many central banks have raised their policy rates in order to control inflation Strong aggregate demand and a rise in the international commodity prices resulted in an increase of external current account and fiscal deficits

International oil prices rises to US$125/barrel

International food prices have reached to US$23.4 per 100 pound

The second half of FY08 particularly proved difficult for Pakistans economy
Monetary Policy Statement

Due to an increase in international oil and food prices, growth moderated, and the combination of growing demand and reduced supply increased inflationary pressures
FY08 FY07 Fiscal deficit (% of GDP) SBP financing ( bln Rs) C.A. deficit (% of GDP) Trade deficit (% of GDP) Exchange rate2 (Rs/US$) Forex reserves ( bln $) YoY M2 growth in % Avg. Inflation % NFNE (YoY) % 20% trim (YoY) % Real GDP growth in % 4.3 -58.6 4.9 6.8 60.4 15.6 19.3 7.8 5.7 6.5 6.8 Target/ Proj H1 4 -62.3 5.0 8.3 13.7 6.5 7.2 3.6 201 3.6 3.7 61.7 15.6 19.9 8.0 7.2 8.7 Year 8.3 689 8.4 15.3 68.3 11.4 15.4 12.0 13.0 17.2 5.8

Monetary Policy Statement

Fiscal deficit raised to 488.1 billion (8.3 percent of GDP). Balance of payments pressures were increased as the expenditures continued to rise, while revenue growth lagged. 80 percent expenditure overruns are due to delay in pass through of international oil prices and other subsidies and underestimation in current expenditures. Nonfood group accounts for 59.7 percent in the CPI basket Multiple monetary policy measures announced by SBP on May 22, 2008 are: rise in the policy rate by 150 bps to 12 percent increase in CRR to 9 percent floor on banks savings/PLS deposit and L/C margin on all imports excluding oil and selected food products at 35 percent.

Monetary Policy Statement

rise in interest rate resulted in declining of aggregate demand through consumption or investment expenditure. demand for goods and services as measured by real GDP less net exports raised from 5 percent to 7.2 percent growth in supply of goods and services as measured by the real GDP slowed down to 5.8 percent from 6.8 percent To meet the liquidity requirements banks started reducing their surplus holdings of government securities i.e. commercial banks holdings of government securities over and above SLR requirement

NSIBA WARIS
Roll no # 139

Limitations of monetary policy

Organized capital market Existence of eligible bills Bank rate and other interest rates Willingness of banks

Organized capital market

The success of monetary policy depend upon the availability of organized capital market. If capital market is not organized then central bank has to face difficulties in controlling credit and implementing monetary policy.

Existence of eligible bills

In the absence of eligible bills ,bank rate is not very effective. If the commercial bills do not have adequate eligible bills ,they cannot change the practice of rediscounting of bills according to the changes in bank rates.

Bank rate and other interest rates

The bank rate policy becomes effective only when the bank rate influences the lending rates .The relationship between these rates does not exist where the money market is not organized.

Willingness of banks
The open market operation will not be successful if the commercial banks are not really interested in it so the banks are willing to absorb securities.

Suggestions
The commercial banks should maintain only a minimum cash reserve and depend upon the central bank for obtaining reserve. The central bank requires that the quantity of money should be increased or decreased to influence the price level.

The bank rate policy should effective only when the lending
rates of commercial bank are affected by changes in bank rate.