Cheaper borrowing: To spur economy, interest rate slashed to 10.5%

Bank says inflation will persist, but insists rate cut necessary for private sector growth.

KARACHI:

The central bank has moved in an effort to stimulate Pakistan’s flagging economy.

Beating market expectations, the State Bank of Pakistan (SBP) on Friday cut policy rate by 150 basis points (bps) – from 12% to 10.5%.

The cut is deep, but necessary, said the central bank.

“Though the 150 bps cut alone may not stimulate the private sector growth in the country, it was necessary for the economy,” said SBP Governor Yaseen Anwar while unveiling the monetary policy.

The rate cut is applicable for the next two months, effective August 13, 2012.

Anwar said the central bank wants to stimulate economic growth without losing focus on the persistent inflation in the country.

The decision follows a dip in inflation – monthly inflation in July 2012 was 9.6%, down from 12.3% in May 2012.

Spurring private growth

The policy rate cut of 150 bps is much higher than market expectations, which anticipated, at maximum, a cut of 50 to 100 bps. The move, however, will be appreciated by the business community as it will reduce the cost of borrowing for the private sector. The business community has long-demanded interest rates in single digits.

The governor, however, was quick to point out that the policy rate cut will not be a panacea for the private sector – electricity crisis, security challenges and political instability continue to add to the cost of doing business in Pakistan.

Improved cashflows

While the policy rate cut follows a dip in inflation, as textbook economics will suggest, analysts believe the SBP decision is mainly based on improved foreign inflows.

Khurram Schehzad, analyst at Invest Capital Markets Ltd, attributed the cut to dollar inflows, including $1.1 billion received under Coalition Support Fund and other grants for the power sector.

“The State Bank has accepted in recent weeks that the impact of monetary policy has diminished in the present economic conditions of Pakistan,” Schehzad said. “This also means that the central bank is banking on foreign inflows instead of keeping the interest rates high due to persistent inflation in the country,” he added.

Stable reserves

The SBP governor said he has no concerns about the foreign reserves of the country.

“Pakistan has received remittances of $1.2 billion in July 2012 while $1.118 billion from US has also supported the foreign reserves of the country,” he said. “Meanwhile, currency swap deals with Turkey and China are also expected to provide a cushion to the foreign reserves,” he added.

The currency swap deal with Turkey will be operational from September while the deal with China is expected to come into effect by the year-end, Anwar said.

Private sector over inflation

The inflation may be down now, but is expected to rise.

According to SBP projections, average inflation for fiscal 2013 is expected to remain between 10 and 11 percent, which is higher than the announced target of 9.5%. Despite that, the bank opted for a rate cut, given the health of private investment.

Private investment has contracted for the fourth consecutive year, and stands at 13%. Total investment, as a percentage of GDP, has fallen to 12.5% in fiscal 2012, which does not bode well for the future productive capacity of the economy, he said.

“The Central Board of Directors of SBP [therefore] has decided to give a relatively higher weight to the state of private sector credit and investment in the economy, knowing that the projected inflation for fiscal 2013 could remain slightly higher than the target,” he said. “However, much would depend on fiscal restraint on borrowings from the central bank, realisation of estimated foreign financial inflows.

Published in The Express Tribune, August 11^th, 2012.