Is it the economy at large? The citizens? Not exactly. What has the impact of the interest rate hike been? Has it resulted in increased savings? Inflation control? Not exactly.
What is this all about then? In simple words, it is a decision made by the elite, for the elite.
Raising the interest rate should put a check on consumer spending and inflation. Have we witnessed that in Pakistan? No, quite the opposite in fact.
The inflation hike is outpacing the interest rate hike. Rather than increasing national savings, it has increased public debt and the repayment burden.
The State Bank of Pakistan (SBP) has raised the key interest rate to 21% in April 2023, which is the highest level of borrowing cost since the 1990s, when it was first recorded.
Consumer lending rates have become impractical and borrowing costs for businesses have become almost impossible without concessional finance. Inflation is hovering around 35-40%, according to official records, but the real inflation rate may be even higher, possibly between 50-70%.
As per the SBP’s website “The changes in market interest rates influence the borrowing cost for consumers and businesses as well as the return on deposits for the savers. Generally, lower interest rates encourage people to save less and consume/ invest more, and vice versa. Changes in the policy rate also influence the value of financial and real assets, impacting people’s wealth and thus their spending. The adjustment in demand finally affects the general price level and thus inflation in the economy.”
It would be great if the SBP could also apprise the nation about the results and validity of this stance.
While increasing interest rates to curb inflation has been a successful policy tool in many countries, it may not work in Pakistan due to the country’s economic structure.
Unlike advanced economies like the US, a significant portion of consumption in Pakistan does not involve banking channels or consumer credit.
Additionally, Pakistan has a low income-to-saving ratio, and over 80% of the population does not have sufficient income to save anything. As a result, the use of interest rate hikes may not align with the ground realities.
In fact, this interest rate hike has added towards the inflationary pressure due to the reduction in money supply that has resulted in increasing the cost of goods and services in the market.
In fact, the recent interest rate hike has actually contributed to inflationary pressure by reducing the money supply, leading to increased costs for goods and services in the market.
However, the hike has resulted in higher borrowing costs for businesses and, more notably, the government. As a result, banks are benefiting from higher returns on public debt as the government’s borrowing from national banks continues to increase.
Since consumer loans make up only a small fraction of commercial banks’ total loan portfolios, the theory of curbing consumer spending by raising interest rates may not be effective here.
Banks in Pakistan are predominantly owned by the elite, who also hold the majority of the deposits. As a result, the profits and returns on savings generated by these banks are primarily benefiting the elite, while the ordinary citizens and poorer segments of society are likely to be penalised by the recent interest rate hike.
Access to capital or finance has already been a significant challenge for non-elite individuals, and this situation is likely to worsen in light of the interest rate hike.
The negative impact of the interest rate hike is also likely to significantly affect small and medium-sized businesses. While some concessional finance schemes, such as those for exports, do exist, they are only available to a select group of the elite.
Furthermore, even if someone is able to access concessional loans at a rate of around 6%, there is no guarantee that they will use the money for its intended economic purpose. Instead, they may choose to deposit the funds in a commercial bank to earn a return that is three times higher.
Such activities have been observed in the recent past when concessional borrowings were channeled towards real estate investments instead of productive economic activities.
The adverse effects of the recent interest rate hike are likely to be experienced over the coming months and years. It is unfortunate that we lack national and institutional accountability mechanisms to scrutinise such decisions and hold those responsible for the negative, long-lasting consequences of their actions.
Pakistan has long suffered from a fiscal divide caused by its regressive taxation system. The poorest segments of society bear the brunt of indirect taxes, while the wealthiest enjoy numerous exemptions and tax incentives.
As the country moves further down the path of polarisation and division, crossing ethnic, religious, political, and institutional lines, it is now also facing a monetary divide.
The writer is an international economist
Published in The Express Tribune, April 25th, 2023.
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