In a move that shocked experts, the State Bank of Pakistan on Saturday decided to cut its benchmark discount rate from 13.5% to 12%, citing lower inflation numbers, a controversial action that is nonetheless likely to reduce borrowing costs throughout the economy.
While analysts at commercial and investment banks had been expecting a rate cut, nobody had expected it to be quite so dramatic. Prior to Saturday’s announcement, the consensus estimate was of a cut between 0.5% and 1%.
In a departure from the trend set by the last two governors of the State Bank, who used to make their monetary policy announcements in televised press conferences, the current acting governor Yaseen Anwar chose to simply issue a press release, and a comparatively brief one at that.
The discount rate is the interest rate at which commercial banks can borrow money from the SBP. It has a direct impact on the rates banks charge their clients, since a lower rate charged by the central bank allows banks to reduce their rates. Lower borrowing costs translate to expanded economic activity as more companies begin to get loans to expand their businesses.
Market analysts are divided about the impact of such a rate cut, however. Muzammil Aslam, an economist at JS Global Capital, an investment bank, said that the rate cut is likely to spur a rally in the stock market as well as increase the prices of many bonds.
“At the same time this is a gamble. Pakistan has said no to the International Monetary Fund and we have a large fiscal deficit before us. We need to see whether this cut helps stimulate the economy,” he said.
Aslam said that it was unlikely that the rate cut would stimulate investment activity, however, since the broader causes of economic malaise – most notably the power crisis and security conditions – would not at all be affected by the central bank’s move.
The reduction in rates is the second one since the departure of the last State Bank governor, Shahid Kardar, who had steadfastly resisted interest rate cuts and had frequently taken the opportunity to use the monetary policy announcements as a platform to berate the finance ministry for what he viewed as a dangerous fiscal profligacy.
By contrast, the current governor – reputed to be reclusive – did not make a public appearance and even in the press statement muted the criticism of the government’s fiscal policy.
Interest rates have declined 2% since Kardar’s departure, though the State Bank insists this is largely due to a drop in inflation, which clocked in at 10.2% during the month of September, according to the Federal Bureau of Statistics. Inflation was at 13.3% in June, though much of the reduction is largely due to the regularly scheduled decennial recalibration of the consumer price index – the primary measure of inflation in the country.
Some analysts view the rate cut as politically motivated, however. One analyst who wished to remain anonymous said that the government was deliberately reducing rates in order to appease industrialists – who have been demanding such a rate cut – just before election season kicks off in earnest.
The State Bank, while acknowledging the risks of inflation rising again, said that it felt comfortable that inflation would be kept below 12% for the fiscal year ending June 30, 2012.
Published in The Express Tribune, October 9th, 2011.
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