While critics cry inflation, sales of luxury items surge

To better manage the economy, institutions like IDBP, PIDC need to be revived.

In a country like Pakistan, where every decision (either good or bad) is looked at with scepticism, a number of commentators and analysts have decried that the reduction in interest rates to 12% will lead to inflation; whereas the overall reduction in inflation (the basis for this reduction) is because of rebasing of the Consumer Price Index.

Meanwhile because of an extremely cash rich economy, the aggregate demand in the country has remained robust. Sell them sugar at Rs90 a kilo, yet we see queues at sweet shops and ice-cream parlours. Car prices go up by nearly 40% over three years, yet Pakistan Automotive Manufacturers Association announces year on year increase in car sales.

The poor, on the other hand, go through a grind of survival forced by higher food prices and transport charges. Over the years, the State Bank of Pakistan (SBP) has used the monetary policy as a tool to counter inflation, which unfortunately, has not yielded the desired results.

One can partly subscribe to the argument that lower interest rates can lead to inflation, however, not many are willing to argue that if lower interest rates can aid in creating installed capacity or in simple words increase supply, then inflation can be countered as well.

Ineffective DFIs

The Development Finance Institutions (DFIs) that we have in Pakistan have largely become ineffective during the last decade. Having limited or no abilities to raise deposits and having a higher cost of funding has made the DFIs uncompetitive against the commercial banks.

Though there are various DFIs in the country including the joint venture institutions, there are two institutions that need to be revived and used for effective project development if we really want to improve installed capacities, bring inflation down in the long run and to ensure that a low interest rate regime is not misused.

These are Industrial Development Bank of Pakistan (IDBP) and Pakistan Industrial Development Company (PIDC).

Both are companies that have a glorious past but have become ineffective in recent times. The purpose is not to find fault with who did what to these DFIs but it is most important that we discuss a course that can make these institutions into a potent force and deliver tangible results.

In simple words, Pakistan is wasting a lot of its resources either because there are goods which are being imported like luxury cars, trucks, buses, mobile phones or there are products which are being imported to meet demand even though capacity has been created in the last few years like fertilisers, sugar etcetera or we are losing productivity because of the energy crisis.

Government’s inherent inefficiencies have not allowed formulation of policies to address the above problems. What needs to be done is that certain areas where demand-supply gap can be covered needs to be analysed.

Due to high interest rates, the private sector is unable to tap credit either because of higher perceived risk by the banks or the projects do not make economic sense because of high financial cost.

In order to plan and address these problems, PIDC and IDBP need to provide expertise and project finance at a subsidised rate allowing effective solution. Under such a project finance scheme, IDBP and PIDC would only finance the actual project and not provide funding which could be misused for purchase of non-project related assets.

This in its sophisticated form would be stimulus to the economy which would allow for better utilisation of resources and a lower cost to the government than of bailing out corporations or providing unlimited subsidies whose results we can see in the form  of our circular debt.

Simply speaking, subsidies given for productive use is much better than subsidies for consumption. This can only happen if the government shows its will to revive institutions like PIDC and IDBP and the SBP plays the necessary enabling role to achieve the goals.

This may not be a perfect idea nor would it be foolproof, but by working together, a win-win solution can be created.

(The writer is an investment banker based in Sharjah)

Published in The Express Tribune, October 31^st,  2011.