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High interest rate: stumbling block in economic growth

At the recent monetary policy briefing, Dr. Reza Baqir, Governor, State Bank of Pakistan (SBP) defended persistent hike in policy rate as a measure to contain inflation in the country. One wonders how hike in policy rate can help the country’s suffering from cost pushed inflation. According to analysts, the three factors responsible for high inflation in Pakistan are: 1) rising interest rate, 2) eroding value of rupee and 3) spiking electricity and gas tariffs. As food and other consumable items are becoming expensive, savings rate is on the decline. In search of safe havens not only small investors are investing in fixed income securities, but commercial banks are also investing bulk of the deposits in government securities. The ongoing fall of stock market is being attributed to the hike in policy rate, resulting from shift in investment to low risk fixed income securities, from high risk equities. Added to this is the most insulting treatment faced by savers when they go to open an account with a commercial bank or a brokerage house under the new Know Your Customer (KYC) regime.

It is no secret that Pakistan’s GDP rate is on the decline due to the poor performance of agriculture and manufacturing sectors, both of these are heavily dependent on borrowing from banks as well as informal lending system prevailing in the country. Farmers need money for buying seeds, fertilizers and pesticides. Similarly, two of largest agro-based industries (textiles and clothing and sugar) are highly leveraged. Other sectors heavily dependent on bank borrowing are cement (on-going expansion), power generation, oil and gas distribution companies (circular debt). The hike in interest rate raises their cost of doing business. If they are able to pass on the hike, the ultimate sufferers are consumers and in case market conditions do not allow this, they have to take the hit.

According to analysts most of the local manufacturing units, particularly those making goods for overseas buyers, are operating at below optimum capacity utilization due to eroding competitiveness, resulting from high cost of doing business. It is on record that Pakistan cannot export surplus wheat, sugar and POL produced in the country, because it cannot compete in the global markets. Height of disappointment is that the storage tanks of local refineries are overflowing because on restriction on use of furnace oil for power generation, but the commodity just cannot be exported, as it also contains high sulphur.

It is on record that in the past production of cars, motorcycles and other domestic appliances increased because of consumer financing. However, with the hike in interest rate not only borrowers are reluctant in borrowing around 16-18 percent interest rate, but banks are keener in investing in government securities, rather than indulging in consumer finance. The housing finance business is also on the decline, which is also proliferating Katchi Abadis. On top of all public transport is disappearing fast because financial institutions are not interested in offering loans to transporters, which is also adding to miseries of commuters.

 

It may be said that the poor GDP growth rate in the country is because of in coherent government policies. It is known to all that nearly 20% of food grains go stale before reaching the market due to the lack of quality storage facilities. The government had announced Warehouse Receipt Financing (WRF) system nearly six years ago but little progress has been achieved. The policy makers fail to understand the urgency because saving this produce can on one hand increase income of farmers and on the other hand enable the country to export surplus and earn extra foreign exchange. One point must be kept in mind that the first step toward WRF is creation of quality grain storage silos and warehouse management system. Once farmers develop faith in warehousing system only then they will keep their produce in warehouses managed by third party.

It is true that Pakistan faces ‘egg or chicken first’ situation when the debate about reducing interest starts. However, the problem cannot be overcome without taking some radical decisions by the Government of Pakistan (GoP), that has to be fully supported by International Monetary Fund (IMF). It is being said that Pakistan needs some structural adjustments. However, a question arises, if the country has been going through structural adjustment programs for years that have not yielded the desired results, who could be held responsible for the failure? Let the GoP and IMF sit together and review the past programs, identify the short comings and then define the future strategy.

Lately, IMF has hinted that success of the current program is also dependent on complying with the requirements of FATF. While the list of items may be long, the GoP needs to regularize gold trade in Pakistan immediately. Arresting the jewelers becomes meaningless unless inflow of gold in the country is regularized. The first step in this direction is that the central bank starts providing foreign exchange for the import of gold, at present the central bank does not provide foreign exchange for the import of gold.

The trade has a suggestion that the GoP seek foreign exchange as loan under structural adjustment program on the pretext that the country has limited reserves. The trade strongly believes that once gold is available freely, export of jewelry will increase manifold. Analysts support the move because official import of the commodity and its sale from local mercantile exchange can help in building credible trail to overcome money laundering and terror financing.

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