Discount rate hike

The State Bank of Pakistan needs to be commended for the increase in the interest rate which it announced on July 30. In announcing the half per cent increase in its policy rate, the central bank governor made it clear that the decision was made based on a high degree of scepticism within the SBP about the ability of the federal and provincial governments to achieve their respective fiscal targets. The discount rate, or the rate that the State Bank charges commercial banks when they borrow from its discount window, is widely viewed as one of the key benchmarks of the cost of borrowing in the country. Interest rates, in turn are highly dependent upon inflation and the government seems incapable of curbing the constant deterioration in the buying power of the rupee, in large part due to its inability to manage its fiscal deficit.

When the government cannot raise enough money to pay for all of its expenses, it just prints more, injecting a larger number of rupees chasing after the same number of goods. This has the dual effect of increasing the prices of goods and services across the board, commonly known as inflation, as well as causing depreciation in the exchange rate of the rupee. The State Bank, as the custodian of the rupee, has been doing its bit to bring to the government’s attention the excessive monetisation of the national debt (an economist’s way of saying the government is printing more money than it should) since the waning days of the Musharraf administration. Perhaps it is time the administration started heeding the advice of the government’s own leading macroeconomists and curbed its borrowing. The government could start by cracking down on corporations and high net worth individuals who cheat on their taxes. It is certainly a better idea than taxing the poor and printing money.

Published in The Express Tribune, August 2^nd, 2010.