Monday, the State Bank of Pakistan lowered its key interest rate by 100 basis points to 14% to boost the economy.
The discount rate was kept on hold at 15% in January after tightening the monetary policy by 500 basis points in 2008.
State Bank of Pakistan Governor, Syed Salim Raza said the decision to reduce the key policy rate has been taken on the basis of assessment that inflation will continue to decline.
He pointed out that the annual consumer price inflation has declined to 19.1% in March from a high of 25.3% in August. Although the projected average CPI inflation for FY09 is around 21%, expected inflation of around 14% for Q4-FY09 and 8% for FY10 illustrates a positive outlook.
Raza said that improved fiscal discipline and contraction in the external current account deficit indicate that aggregate demand is showing a downward trend. This will help narrow the output gap and strengthen the positive outlook for inflation, he added.
Talking about challenges that the economy is facing, the central bank governor said that despite positive outlook for inflation, the real challenge is to improve the business climate. The difficulty is that not only has the demand for credit by the private sector reduced sharply but that the supply of credit by banks has also remained subdued, and the two issues are difficult to disentangle, he said.
In March, the World Bank agreed to provide US$500 million interest-free loan to Pakistan to help the country to address economic crisis. This follows US$7.6 billion fund from the International Monetary Fund in November 2008.
Last week, the IMF said Pakistan that it was premature to reduce interest rates at this stage. But, the IMF saw the need to re-assess interest rates down the road in order to stimulate a pick-up in economic activity.
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