Monetary Policy - November To December, 2009

A cursory look at key macroeconomic indicators shows substantial improvements on multiple fronts. Inflation (YoY) has fallen to 8.9 percent in October 2009 and is expected to remain in the vicinity of 11 percent by the end of current fiscal year. External current account has improved considerably, positively altering its projected trajectory. With government borrowings from the SBP remaining within the quarterly limits, the broad money (M2) has also remained contained along the projected path. The real sector is also showing signs of improvement as the large scale manufacturing (LSM) stage a recovery after a protracted declining phase. However, a close inspection of these encouraging developments together with a pragmatic assessment of prevailing security situation in the country and fiscal uncertainties invite caution and further analysis.

Recent month-on-month inflation changes in headline and core measures continue to be volatile and on the higher side, oscillating between 0.5 and 1.7 percent in case of the former and remaining stuck at 0.8 percent in case of the later. A reassuring fact is that the number of items in the CPI basket showing higher monthly increases relative to an historical benchmark has come down significantly. However, at the same time, the number of items displaying significant inflation persistence has also increased, which indicates the probable entrenchment of second round effects of inflationary process. The poor administration in the supply chain of some food items is not helpful either in positively altering inflation expectations. A higher than projected fiscal deficit for FY09 has also changed some underlying assumptions for inflation outlook in FY10. In addition, the full impact of electricity and gas price adjustments, a necessary part of fiscal consolidation measures, and recent resurgence of international commodity prices, on the back of early signs of global economic recovery, remains a source of uncertainty for inflation outlook.

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