KARACHI - The State Bank of Pakistan (SBP) on Saturday kept the key policy rate for April-June unchanged at 14 percent on the heels of positive macroeconomic indicators such as restrained government borrowing and favourable external current account position, but warned that the overall state borrowing and inflation still run very high. The current account deficit for July-February was a provisional $98 million, compared with a deficit of over $3 billion in the same period last year. The governments borrowing from the State Bank has fallen to Rs 116 billion from July-Decembers Rs 329 billion. While the governments borrowing from the SBP has been relatively restrained, its total borrowing from the central bank and commercial banks is still very high, with Rs 329 billion borrowed from July 1 to March 12. Similarly, the consumer price index in February increased 12.91 percent compared to the corresponding period a year ago, though it was down 0.74 percent from January because of a decrease in food prices. But the SBP feared inflation might jump up due to the recent removal of General Sales Tax (GST) exemptions and a delay in removing subsidy on the petroleum products. The SBP also said the immediate risks to macroeconomic stability seem to have subsided at least for the next two months. However, there is little room for complacency as the risks to the economy could escalate if meaningful economic reforms are not initiated to address the structural weaknesses, the central bank said in a monetary policy decision, which was taken after its Central Board of Directors meeting held under the chairmanship of SBP Governor Shahid H Kardar in Lahore. The SBP said inflation persistence still remains high, which is largely formed by recent past levels of inflation and perceptions of economic agents about the credibility and direction of monetary and fiscal policies in controlling inflation and promoting long-term sustainable economic growth. Perceived credibility of monetary policy is also influenced by the behaviour of monetary aggregates. In this respect, while government borrowing from the SBP has been contained to end-September 2010 level, growth in the public sector borrowing is still very high and that of the private sector low. Further, given the financing requirements of fiscal authorities, budgetary as well as non-budgetary borrowings for the procurement of commodities and addressing the circular debt-related issues, the likelihood of an ease in such borrowings is small. This means that risks to macroeconomic stability could increase in the next fiscal year. The current stability in the financial markets provides valuable time to initiate structural reforms. Not only are urgent measures required to address the energy crisis to increase productive activity but the fiscal position also needs considerable strengthening to cope with rising debt obligations and to ease borrowing pressures on the banking system, it stated. Although some measures have been announced to contain the fiscal deficit of FY11 and inflation has eased somewhat, more work is required to build on these initial efforts by maintaining progress on comprehensive tax reforms, transparent rationalisation of subsidies, and the development of a forward-looking debt management strategy. This will require support from across the political divide and from other state and civil society institutions to ensure their smooth implementation. These measures would help check the level of government borrowings from the banking system, creating space for the private sector and lowering their borrowing costs thereby supporting the utilisation and expansion of the economys productive capacity. Initiation of these reforms has become critical since private and public sector investments are falling while total debt is rising sharply and expectations of high inflation are becoming entrenched, it said. According to the SBP, the decline in year-on-year inflation from 15.5 percent in December 2010 to 12.9 percent in February 2011 can be attributed to three factors. First, a gradual dissipation of the effect of the flood on food prices; second, an incomplete pass-through of high international oil prices to the domestic market and a smaller adjustment in electricity prices than required by the projected size of the power sector subsidy; and, third, a reduction and thereafter containment of the stock of government borrowings from SBP to around Rs1290 billion (on cash basis). The SBP is confident that the government will adhere to the mutually agreed borrowing limits from SBP and, in recognition of the high level of inflation, will aim to lower them further. This should facilitate SBP in aligning monetary expansion with the level of productive economic activity while improving its composition in favour of Net Foreign Assets (NFA). By 12th March, 2011, the year-on-year growth in reserve money was 15.9 percent, which is slightly lower than the growth rate observed at the time of last monetary policy decision in January 2011, and share of NFA of SBP in reserve money has increased to 27.5 percent compared to 22.5 percent at the beginning of FY11. A continuation of these positive trends can potentially have a beneficial effect on inflation in the next fiscal year, it mentioned. However, the rise in public debt with a considerable short-term maturity profile combined with reduced availability of bank credit for the private sector at higher interest rates has created challenges for monetary management in terms of striking a balance between containing inflation and promoting economic growth. By end-December 2010, the year-on-year growth in governments total debt was 14.8 percent, with 45 percent of the tax revenue being absorbed by interest payments. The year-on-year growth in private sector credit, on the other hand, was only 5 percent up till 12th March 2011. Without increasing the private sectors investment and hence its contribution to economic growth it would become more challenging for the economy to generate sufficient revenues to meet its debt obligations in the future, especially with the terms of trade shifting in favour of sectors with modest contribution to tax revenues, it said. The recently announced tax measures, estimated to raise approximately Rs53 billion in the remaining months of FY11, together with a cut in planned development expenditures and postponement of some subsidy payments may help in reducing the fiscal deficit for FY11 to some extent. Given the delayed announcement and temporary nature of some of these measures, the improvement in the fiscal position will require these efforts to be consolidated in the forthcoming budget. Thus, implementation of a credible medium term budgetary framework and renewed efforts to abide by the principles of the Fiscal Responsibility and Debt Limitation Act (2005), geared towards reducing the revenue deficit, are required to strengthen the fiscal position on a sustainable basis, it added. On the financing side, only Rs 48 billion were received for external sources to finance the budget during H1-FY11 against the budget estimate of Rs 230 billion for the year. If these external flows are not released in a timely manner, there is a risk of further substantial government borrowings from the banking system, which will make liquidity management more challenging. The government has already borrowed substantial amounts, Rs 329 billion during 1st July12th March, FY11, through various instruments, increasingly in the 3-month Treasury Bills. The incremental requirements of the government for Q4-FY11 and a debt plan that focuses on long term borrowings are awaiting announcement, it revealed.