grip on market gaps and interbank activity, thus strengthening the market management capability and sbp's forecasting capacity. between apr - dec 2005, not only omos have been conducted both ways, but with a greater flexibility of tenors and frequency. additionally, being active in the swap market has helped sbp treasury to mop - up / inject usd / rupee liquidity in the money market, as and when required, thus complementing the monetary management. this has resulted in managing excessive market volatility, providing effective signals / direction to the market and to set benchmarks for the rupee inter - bank market in line with the monetary policy stance. consequently, o / n rates now move within a 100bp – 150bp range compared to previous trends when it fluctuated between zero to 9. 0 %. iii. monetary outlook for 2006 and associated challenges. current fiscal year is an important departure from the preceding few years ’ monetary stance and trends observed. after 3 - 4 years of lax monetary policy, pakistan faced significant monetary overhang since the growth in broad money supply every year exceeded the growth in nominal gdp. since the second quarter of 2005 monetary policy was tightened as the headline inflation, measured by consumer price index ( cpi ), reached close to 11. 1 in april 2005 - edging beyond the yearly target of 8 % with wholesale price index ( wpi ) pointing to the risk of moving to double digits. it has to be further recognized that given structural issues, the inflation threshold for developing countries is high inflation in excess of 8 - 12 % is found to hurt economic growth. 1 to start off, sbp raised discount rate to 9 % in april 2005 which generated an uptrend in interest rates on t - bills auctioned and sharpened its yield curve : 3 months tbill rate rose from 4. 3 % jan 05 to 8. 1 % by mid april 2006, 6 months 4. 3 % to 8. 3 % and one year from 5 % in early 05 to 8. 8 %. has this monetary tightening achieved the desired results i. e. of curbing inflationary pressures? latest trends of cpi are comforting but reveal different levels of deceleration across cpi categories and point to lingering concerns whether the deceleration will continue and / or if the decline in cpi and its components is there to stay. some numbers are illustrative of this concern. • while cpi had dropped to 6. 9 % yoy by march 2006

ishrat husain : sustainable growth in the financial sector of pakistan address by mr ishrat husain, governor of the state bank of pakistan, as chief guest at the symposium organized by the public relations management group, karachi, 29 april 2005. * * * it is pertinent to ask whether the reforms brought about in the financial sector of pakistan will persist generating sustainable growth in the sector or quickly dissipate. in my view there are at least eight factors that attest to the sustainability of growth in the financial sector. of course, the sector cannot be divorced from the overall external, domestic and macroeconomic conditions. if there is a breakdown in political stability or macroeconomic situation is under stress, then these factors will not be operative. this analysis assumes stability, continuity of good policies and good governance. what are these factors? first, capital base of the banks has been strengthened by raising the minimum capital requirements from rs. 500 million to rs. 2 billion. this will be raised further in the coming years. in addition, the capital adequacy ratio which reflects the amount of capital to finance the risk weighted assets is now at about 11 percent for the banking industry as an average against the minimum requirement of 8 percent. as the banks mainly use the depositors ’ money to take risks they should also have their shareholders ’ money at stake too. this high capital adequacy ensures that the bank management exercise caution and prudence in granting of loans. second, the quality of assets of the banking system has improved during the last few years. gross non performing loans to gross advances for the commercial banks have come down from 25 percent to less than 10 percent while the provisions held by the banks against these npls cover about 70 percent of gross npls. consequently, the net npl to net advances ratio has shown a remarkable decline to 3 percent while is comparable to international standards. the flow of npls has dwindled to less than 5 percent that means that 95 percent of the loans in banks ’ portfolio are being fully serviced on time. third, the earnings of the commercial banks have risen not because they have invested in stock market or real estate but because healthy competition and restructuring have resulted in efficiency gains. the spreads between the deposit and lending rates now range between 3. 5 to 4. 5 percent compared to 7. 5 to 8 percent five years ago. the spreads have declined because the drag of npls has disappeared, the corporate tax rates on the profits