interest on lending. there is no doubt that the spreads of the banking system have been high, but with the growing demand for credit and liquidity constraints on the margins, banks are having to pay higher deposits rates. with growing competition, it is expected that banks will need to tighten their spreads and offer better returns to depositors, while launching efforts to reduce the administrative costs to maintain their profitability. iv. conclusion effective economic management and liberalization together have helped pakistan achieve a fair degree of economic stability, while setting the stage for economic restructuring and industrial development. however, preliminary results for fy06 outcome do highlight some short - term risks and vulnerabilities. the fiscal deficit is expected to exceed target in fy06, because of the unanticipated earthquake spending and continued stagnating of the tax / gdp ratio, despite enhanced tax collection. simultaneously, the external current account deficit will be over 4. 0 % of gdp as the trade deficit is likely to reach $ 6. 8 billion with import growth outpacing the rise in exports ( even though exports will reach new record levels ). while about one - fourth of the trade deficit stems from the rise in oil prices, the broad based growth in imports of machinery, capital goods and raw material augurs well for fresh investments and enhancement of industrial capacities. import dependence seems inevitable as pakistan needs to raise its investment levels and expand and diversify its industrial base and capacities. going forward pakistan plans to raise its investment in infrastructure and human resources, as shortcomings in these areas are now hurting pakistan ’ s industrial and export competitiveness.

fy05. notwithstanding the 1. 5 % rise in discount rate in april 2005, domestic demand pressures remained high as both private sector credit and government borrowings remained strong. sbp ’ s continued monetary tightening and government ’ s supply side interventions to curb shortages of key products has together helped weaken inflationary pressures ( built up since late 2004 ) with headline cpi declining from 9. 3 % on yoy end june 2005 to 6. 9 % in march 2006, and core cpi coming down from the range of 7. 0 - 8. 0 % during jun fy04 - oct - 05 to 6. 7 % by end march 2006. it is expected that the cpi inflation rate would be in the range of 7. 7 - 8. 3 percent in fy06. underlying these trends is the expectation that ( i ) monetary policy will remain tight, ( ii ) domestic fuel prices will not rise further in the remaining months of the fiscal year, and ( iii ) supply of essential products would be managed effectively. monetary policy, its conduct and transmission mechanism has also benefited from the structural transformation of the economy and the banking system, which forms a significant component of the financial system. what is appropriate to acknowledge is that the central bank ’ s independence in monetary management has been respected despite the resistance to interest rate hikes. and that the dividends of interest rate adjustments are visible since inflationary trends have shown a persistent downtrend since the beginning of january 2006. most encouraging is the fact that interest rate adjustment and its transmission mechanism has started to work. sbp has increased its interventions to ensure that the short term inter - bank market rates remain close to the discount rate. the higher inter - bank market rate, tight liquidity conditions and demand for credit have increased the weighted average lending rate by close to 200 bps over july - february fy06. while private sector credit remained robust, it rose by 18 % relative to over 25 % in the preceding year. overall impact of this would be more visible but for high recourse of the government to sbp financing. fiscal dependence on sbp generates inflationary pressures and deters growth of the long - term government securities market priced in line with the prevailing yield curve. iii. transformation of the banking system process of modernization of the banking system is well underway as there is no scope for complacency in pakistan after the tremors and economic losses caused by the asian financial crises in 1997 / 98. it has