Central bankers are typically the most risk averse amongst policymakers. So when they take a gamble as big as a 1.5 per cent cut in the benchmark interest rate in the country, it is worth paying attention to the reasons as to why they did so. On Saturday October 8, the State Bank of Pakistan (SBP) issued a press release stating that it had decided to reduce the discount rate — the interest rate at which it lends money to commercial banks — to 12 per cent from 13.5 per cent, citing lower inflation.
There is no question that the move has a potential upside: the cut by the SBP is likely to have a cascading effect across the financial system, reducing borrowing costs throughout the economy, thus making it easier for businesses to grow. No sane Pakistani would be opposed to lower rates if they help accelerate economic growth and we hope this measure by the SBP has its desired effect. But given the allegations that the move was politically motivated, it is worth questioning the wisdom of reducing interest rates by 150 basis points in one go.
For starters, it had emerged that the analysis within the central bank was not unanimous in supporting quite so dramatic a rate cut. Indeed, there is considerable debate amongst the economists at the SBP as to whether a cut in interest rates would hurt or help the economy. While economic growth should be the primary concern of any government, it is not the job of the central bank to allow the administration to take short-cuts, particularly at the expense of potentially fuelling inflation. This is precisely why central banks are given more independence than any other part of the government’s economic management team.
Some experts believe that a reduction in rates may well cause inflation to rise from its already high levels and cause an acceleration in the depreciation of the rupee. This is highly dangerous at any time, but particularly dangerous when the government is expecting to make large payments on its external debts over the next few months. A better strategy might have been a more staggered approach in reduction of interest rates, balancing the concerns between inflation and growth. The SBP has decided to take a gamble by doing it all at once. Let us hope for the sake of the Pakistani economy that it works.
Published in The Express Tribune, October 11th, 2011.
COMMENTS (16)
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@Adeel:
You are so naive. Its people like you who make Muslims sound idiotic and unintelligent. The next time you read about ‘interest’ in the Quran, please try to read it in the spirit in which it was written. If you are going to read ancient Arabic prose that contains the entire code of life, then research the language and understand the history and the culture of that area and of that time. Since your laziness will be an obstacle, as I imagine it usually is, refrain from making ignorant comments. If you go and read your history, you will find that a lot of people (and the Jews were notorious for this), would lend out to the needy at very unfair rates of “interest”. Now since there was no paper currency at that time, it was mostly done through trade and barter. Eventually men would end up owing their houses, wives, daughters, camels etc. The fact is that these people needed a loan because they were always strapped for cash and needed a livelihood. They would take the loan and try and start trade/business/means of earning bread. Most lenders would pick and choose their victims and charge an unreasonably high rate of interest, knowing that the borrower would “default” and so the lender would have claim on all the defaulter’s assets. Islam was simply trying to stop this practice. Basically, the message was not to charge interest to someone who is in need. Meaning – don’t take advantage of the weak. This is the overall message. A simple and beautiful code that appeals to the human intellect. You know the message to be true because it was already ingrained in you…you were already wired for it, so to speak. It’s the same feeling you get when you stand on top of a mountain and look around to admire the beauty. You were also wired for that feeling. What you feel that time is pure and the absolute truth. But then God also creates idiots like you to test the rest of us…to test our faith against your stupidity. You and your bearded cult over complicate matters as usual, starting your nonsense with the words, “Interest is HARAM” – pretending like you understand anything. Why is interest HARAM? A moron like you will say, “Because God said so”. Please use your miniscule brain and try and get into the depth of things.
When a commercial bank lends money to people and charges interest, do you think it’s taking advantage of people? No its not. It’s providing capital at the going interest. It’s making a spread by borrowing at a lower rate and charging at a higher rate. It’s fuelling the economy for growth – for people to start businesses and provide employment and income. Don’t bring your “Haram” talk in this. You understand nothing about banking or capital markets. You only understand what uninformed, ignorant and irresponsible bearded men teach you. Islamic Banking converts this “interest” into profit. It’s just a technicality and they have multiple products to do this. Otherwise, it’s exactly the same thing. Or are you trying to fool God?
@Meekal Ahmed: Cannot agree more. I fear that the downward journey of inflation won't last for long. So, if SBP reduced it only to increase it again 6 months from now, it will hurt SBP's credibility as a regulator. And you know monetary economics more than me; you know what happens when economic agents stop giving importance to what central bank does.
@Asim+Ali:
No one should be looking at the "nominal" rate of interest. Everyone should be looking at the "real" rate of interest -- that is the nominal rate adjusted for inflation. If you do that the real rate is about 1.5-2.0%. That is hardly what you would call a "tight" monetary policy.
A tight monetary policy is forced on the SBP because fiscal policy is too loose. It seems we could now end up with a loose fiscal stance and a loose monetary policy stance as well. That is the problem.
If interest rates were down to 6% as you suggest, the real rate would be MINUS -4%! Low interest rates punish savers and encourage borrowers to borrow, often imprudently, pushing up debt.
Interest rates should be in single digits. Even 12% makes cost of borrowing very expensive. Interest rates should be dropped to 6%.
@Adeel: Allah tahlah says in the Quran who ever deals with interest is at war with him and the messenge Tell me how do we cater for inflation in the system then ? And can the Islamic banking system exist in isolation to the rest of the world ?
@Adeel: So is internet and watching TV, as pictures are not allowed. Get back to the basic topic and do not bring islam in..
On 13 Nov 2008, SBP raised policy rate by 2 % age points in 'one go'.
I think it's a good move to give the economy the needed stimulus at this point.
Besides, it is questionable at best whether high interest rates could help further reduce inflation that was sparked mainly by food price hikes deliberately engineered by the govt to transfer over Rs. 300 billion last year from the urban economy to its mainly rural PPP constituency. It not only sparked inflation, but the resulting monetary policy starved the urban industrial and service sectors of the needed credit and investments to continue growing.
Please read more at http://www.riazhaq.com/2011/01/pakistans-rural-economy-showing.html
Economy is haraam.. Ya Allah Khair
@ Adeel and your suggestion is what....? I would suggest you present an alternative rather than making un-neccesary, uncalled for and irrelevant comments.
I personally think that it is an interesting move by the central bank. It was expected that the interest rates would be cut due to slowing down of inflation. However, the perception given out by the central bank to the market is as important as the act of reducing the interest rate. and sadly in my view, in this case it seems as though the governor has acted under pressure from the finance ministry, who would prefer lower interest rates so that they can borrow more cheaply during the upcoming election year.
@Adeel: Try starting even a small sized company (10-50 emps) without involving interest and then talk. These restrictions were for a time when there was no paper (fiat to be specific) currency and thus do not apply any longer. No country, even Saudi Arabia, can function without interest. You are a literate person, and I suggest that you read any intro to economics and finance book instead of getting your information from religion. If you had a disease would you go to your imam or a doctor? Similarly, you need to have understanding of finance or else rely on someone who has the requisite qualifications.
@sharifL:
Inflation in Pakistan is due to imports and the falling rupee?
Ever heard of large budget deficits and unrestrained government borrowing?
This is a very good and balanced Editorial and I too hope that things will work out for the better. But I am not sure.
There has been a cumulative 2% cut in the policy-rate since Shahid Kardar left. Sounds like someone would like his job by posing to be more accomodative than Shahid was. Time will tell who was right.
On balance, I think this is a risky move and I have yet to hear a PROFESSIONAL economist endorse it. The cost of capital is only ONE determinant of investment as countless econometric models attest. Investment will NOT rise unless there are other supporting factors.
Even if we do not see an up-trend in inflation, bringing it down will be delayed thus prolonging its duration in double-digits. Both are just as cruel when it comes to the fixed income groups and the poor who have no way to protect themselves.
Interest is HARAM. Allah tahlah says in the Quran who ever deals with interest is at war with him and the messenger. Can we afford to go at war with the creater. I do not think so. Then we wonder why are country and us are doing so bad. WAKE UP PEOPLE before its too late. Follow the greatest man that world has ever seen are beloved prophet Muhammad (PBUH). If you want change follow him and we could never go wrong in this world and here after. May Allah tahlah have mercy on us and show us the right path.
When interest rates fall all that people do is by more and more consumer goods. Its not as if new investment is being taken out given the available spare capacity.
When the economy is doing poorly the central banks normally cut rates in order to promote stronger growth at the expense of low inflation. That appears to be the logic behind this move. It is true that lower interest rates can cause inflation, but in Pakistan's case the inflation is more related to imports and with falling rupee value, things won't get cheaper. In fact it will encourage spending, which in turn increases jobs. It can work it many ways. Taking loans to build houses or open new businesses. Only countries which have lower interest rates have healthier economies. Prime example is Germany, where the jobless numbers have been declining consistently. Hopefully It stimulates business and economic activity in the private sector. Bottom line is fewer jobless.