Interest rate hike

Mr Kardar’s actions are reminiscent of the central banker who was able to get the American economy out of...

In raising the benchmark interest rates again by half a percent to 13.5 per cent, the State Bank of Pakistan has announced itself as another Pakistani institution willing to pursue sound policy and ignore political pressure. Indeed, if anything, the central bank tried to exert its own pressure by outlining the failure of the finance ministry to curb government expenditure and raise more tax revenues.

There has been the usual hue and cry that accompanies any rate hike with many a trade group announcing their opposition to the move. And indeed having the benchmark interest rate in the country be quite so high is not good for the economy. But the State Bank’s detractors should realise that the interest rates they set are a symptom of the woes that ail the economy, not the disease itself. That would be the profligacy of the government and the refusal by Pakistan’s economic elite to pay taxes. Unto itself the rate hike will not curb inflation, but Mr Kardar’s actions are reminiscent of the legendary American central banker, Paul Volcker, who was able to get the American economy out of stagflation by taking decisive action on interest rates regardless of the outcry.

In increasing the cost of borrowing, the central bank is forcing the government to look for cheaper means to finance the deficit, like not having one in the first place. The logical next move, and one on which the SBP’s record has been more disappointing, is to restrict the government’s borrowing from the central bank, which in essence is just printing more money. This is the single biggest cause of inflation in the economy since most indicators suggest that the other possible sources of inflation – rising input costs or surging demand – are unlikely suspects. If the finance ministry wants the SBP to stop raising interest rates, they should start collecting more taxes.

Published in The Express Tribune, October 1^st, 2010.