Over the last few years, Pakistan’s economy has been hit by the worst of both worlds: low growth and high inflation. Now, however, the State Bank of Pakistan (SBP) has put aside worries about rampant inflation and cut the rate of interest by an astounding 150 basis points to 10.5 per cent. The move is a bold one but results are far from guaranteed. Banks have been reluctant to lend out money to a crippled private sector and, if that trend continues, the interest rate cut will have a negligible stimulus effect. In the current financial year, the net flow of credit to the private sector has been an abysmal Rs18 billion. If that isn’t significantly increased, Pakistan may well continue down its low-growth/high-inflation path.
Another possible danger of the interest rate cut is that, more than the private sector, it will simply lead to further government borrowing from the banks and that is where the inflationary pressure will mainly come from. Not only will this interest rate cut encourage the government’s bad borrowing habits, it will also reduce some of their debt repayments. The problem of government borrowing is so acute that the SBP had to warn the government that excessive further borrowing could be both counterproductive and illegal. The temptation to do so, however, will be ever present, especially in the run-up to elections as the government tries to get its hands on whatever money it can to win over reluctant workers.
As drastic as the interest rate cut seems to be, ultimately the performance of the economy will likely rest on external factors. The international price of oil, which has begun rising again, and the long-overdue payments from the Coalition Support Fund may ultimately be more consequential to the direction of our economy. At home, the government’s inability to provide a regular supply of electricity is surely going to dampen any private sector enthusiasm for borrowing. What is the point of borrowing from banks to expand your business when the government cannot even guarantee electricity for half the day? These are the real problems facing our economy and it remains to be seen whether tinkering with the interest rate will change the situation.
Published in The Express Tribune, August 12th, 2012.
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The primary driver of inflation has been food price hikes which have transferred from urban to rural areas about Rs 200-300 billion every year since 2008. This has sparked significant rural consumption boom as seen in big new car and motorcycle showrooms and shopping malls in many small towns across Pakistan. The lowering of interest rates are likely help the boost urban consumption as well.
http://www.riazhaq.com/2011/01/pakistans-rural-economy-showing.html
Such drasic reductions in short span of time will push inflation rate further. Investment is not directly related to Interst rate cut. Other factors, Law and order, Electricity, Forex rate and govt borrowing and spending are more critical. Another foolish move by SBP.
Indeed other problems particularly the power crisis needs to be addressed but interest rate cut would provide a much needed breathing space to private sector which is long overdue.
Inflation could be redressed through direct intervention since a leading factor of core inflation in Pakistan is distortion of free market practices to begin with.
Couldn't have agreed with you more. Very objective analysis.