Feb 25 - Mar 02, 2008

Over the years, in an attempt to contain inflation, central bank has been raising interest rates. While there has been increase in lending rates there has not been corresponding increase in return on deposits. There has been crawling increase in yield on treasury bills. All these factors have contributed to unprecedented spreads and enhanced income for the commercial banks.

In the latest Monetary Policy Statement the central bank has again expressed its intention to further increase the interest rates. Though, the central bank has attracted a lot of criticism for following persistent increase in interest rates, Governor State Bank of Pakistan has been adamant and telling every one that increase in interest rates has helped in containing inflation.

It is also on record that government borrowing has been on the rise due to a number of factors, from less than targeted revenue collection to increase in expenditures. The disruption in economic activities has largely been responsible for lower revenue collection but more importantly political uncertainty has acted like a double-edged sword.

Business community has been complaining about the rising cost of doing business and eroding competitiveness due to hike in interest rates. There has been increase in average lending rates, discounting rate and export refinance rate. However, Governor State Bank is correct to a large extent in saying that financial cost alone has not been responsible for the eroding competitiveness of the local manufacturers. Partly the manufacturers' inefficiencies, load shedding of electricity and gas, rising utility charges and interruption in business activities, all put together, are responsible for erosion in the competitiveness. Most of these factors are manageable had the government and the business community being a little more vigilant.

To begin with, the government's attention has been distracted from economy due to the election. Return of Benazir Bhutto and Nawaz Sharif to Pakistan and later on assassination of Benazir resulted in further polarization and election had to be deferred. Thanks to Allah that 18th February elections were peaceful and most of the political parties have accepted the results. However, anti President Pervez Musrarraf statements are complicating the issue and hinting towards another round of confrontation. If the situation prevails installation of government could be further delayed, adding to political uncertainty, hike in government expenses and disruption in economic activities.

Over the last five years Pakistan's GDP growth rate has been reasonably good, tough much lower compared to India and China. However, the slow down in creation of new productive facilities, non-availability of exportable surplus, declining exports and rising imports have upset the equilibrium. Adhoc and inconsistent decision making is further complicating the situation.

The next government faces two key issues containing inflation and ensuring uninterrupted energy supplies at affordable cost. The policy planners must remember that crude oil prices will continue to hover above US$ 90 per barrel. Therefore, alternative indigenous energy sources have to be developed to minimize dependence on imported fossil oil. For ensuring uninterrupted electricity supply at affordable cost electricity generation has to move away from thermal to hydel and nuclear energy.

Policy planners must also try to find ways for increasing production and productivity of the agriculture sector. Disbursement of agriculture loans has increase but interest rate being charged is very high compared to the interest rate being charged from the manufacturing sector. It may be true that crop insurance is not common, because it was never made mandatory. The time has come to secure all the loans extended to the agriculture sector. It must be kept in mind that seeking insurance cover for all the mortgaged and hypothecated assets is mandatory. By the same token all the agri loans also need to be collateralized as well as insured.

Rising imports are not only eroding foreign exchange reserves but also contributing towards erosion of rupee value against dollar. Since export growth has not been sufficient to meet import bill, trade deficit has been increasing and neutralizing the benefit of record inflow of remittances. Quantum of FDI inflow is very low and proceeds from privatization is almost at zero for some time.

To accelerate the GDP growth rate and produce higher exportable surplus it is necessary that fresh investment should be made in creating new productive faculties. To achieve this target lending rates have to be reduced. Commercial banks have enjoyed exceptionally high spread of around 7.5% for a very long time. Now it is the responsibility of the central bank to convince the commercial banks to boost lending by reducing the interest rates. In the past the government has followed SRO-based lending and the same could be done again to boost investment.

It has been stated repeatedly in the past that hike in interest rates cannot help in containing inflation because of overflowing liquidity best stated by M2 growth. Unless this surplus liquidity is utilized for creating new productive facilities, inflation cannot be contained.

Some of the economists are of the view that declining capacity utilization of the existing manufacturing facilities and slow down in the creation of new facilities hints towards recession. The trend seems more dangerous because of a combination of rising prices and economic downturn. It is a unique situation and demands radical decision making. Else the country would plunge deeper into problems.

Pakistan needs to boost its exports and also contain imports to bridge the widening trade deficit. Since passing on the enhanced cost is not possible the only solution is to optimize cost through improved capacity utilization and higher efficiency.