HIGH INTEREST RATE INCREASES COST OF DOING BUSINESS

ISMAT SABIR
Jan 26 - Feb 01, 2009

The low level of savings in Pakistan is mainly attributed to mostly negative real interest rates on savings instruments. The rate of return on saving schemes, by the banks and National Saving Centre, is in between 10 to 12 percent while inflation rate has increased to 24 percent in September 2008 from 8.4 percent in September 2007 that has discouraged the saving tempo.

Moreover, Pakistan has a consumption oriented society, there are huge expenses on Eid festivals, marriages, parties etc., and despite SBP efforts towards financial provision of financial services for everyone, but funds of small savers could not be tapped in the formal sector.

The analysis shows that profitability of commercial banks in FY08 was significantly impacted by the factors of rising inflation, accumulation of non-performing loans, lower demand for consumer financing due to rising interest rates, etc. The decline in value addition is exhibited by discount and guarantee houses, venture capital companies and housing finance companies.

However, value addition in modaraba and investment companies and mutual funds increased modestly. The profitability of mutual funds and modaraba companies has seen significant improvements in H1-FY08, it was adversely hit by poor performance of equity markets owing to adverse political instability and weaknesses in macroeconomic fundamentals, the SBP report indicated.

In medium to long-term perspective, Pakistan's growth momentum could not be sustained without improvement in domestic saving rates. Efforts are, therefore, needed to encourage savings in the economy so that investment needs could be financed by the domestic sources. The problem is that to encourage saving the SBP increased rate of return on government schemes and also instructed banks to give fair return to the account holders. But this step has shown negative effects on manufacturing sector as cost of doing business has increased.

The official figures indicated that private investment in LSM is declining, which is attributed to acute input constraints, primarily that of electricity and gas, that forced temporary closures, persistently high inflation, which creates uncertainty and make investment decision difficult.

The growth in services as well as commodity producing sectors is highly correlated with the consumption demand. It appeared that due to the recent trend of high inflation, high interest rates, tax increase and decline in corporate earnings, the consumption demand decreased and may reduce in future also.

This disappointing outcome was a result of a number of factors like severe energy shortages, not passing impact of decreasing international oil prices to the consumers, rupee depreciation and weak external demand due to the global recession and slowdown in domestic demand.

Large scale manufacturing (LSM) continued to decline during Q1-FY09. It registered a negative growth of 6.2 percent as against a growth of 7.3 percent in Q1-FY08. This decline in LSM production is based on seven sub-sectors, having 72.4 percent weight.

Power shortages, as in FY08, continuously affected almost all manufacturing sub-groups. Textile sector in particular, was jolted by other multiple shocks as well as imported inputs go into textile production process.

The economic survey indicated that Pakistan's manufacturing sector recorded the weakest growth in a decade during 2007-08. Overall manufacturing posted a growth of 5.4 percent during the first nine months, July-March, of the year 2007-08, against the target of 10.9 percent and 8.1 percent of last year.

Large scale manufacturing, accounting for 69.5 percent of overall manufacturing registered a growth of 4.8 percent only in the fiscal year 2007-08 against the target of 12.5 percent and last year's achievement of 8.6 percent. Depreciating rupee value increasing accumulated impact of monetary tightening and increased cost of doing business were responsible for making Pakistani goods in competitive in the international markets.

The manufacturing growth exhibits a moderate trend showing financial indiscipline during the outgoing fiscal year has already caused severe macroeconomic imbalances, for which, Pakistan is likely to pay a heavy price in terms of deceleration in growth and investment, and the associated rise in the levels of poverty; widening of current account deficit and the rise in public and external debt; a loss of foreign exchange reserves and the associated pressure on the exchange rate and most importantly, higher inflation and the associated rise in interest rates.

An important contributor to the slowdown in GDP growth was investment demand in the country reflecting investors' cautious response. The FY08 contribution of investment demand in overall GDP remained the lowest in last four years at 0.7 percent. In contrast to a relatively balanced FY07 growth, the major impetus to FY08 growth came from a sharp rise in private consumption demand. This appears to have further strengthened inflationary pressures in the economy.

As against the sharp slowdown in commodity producing sector and decline in investment demand during FY08 there was a sharp growth in investment in telecommunications and financial industries. This significant growth in services industry was seen first time in the current decade.

The trend of a robust growth in construction sector continued in FY08 as well and much for the same reasons; public sector development spending on infrastructure and strong private demand for residential and commercial properties. However, rising prices of construction material and a slowdown in housing finance by commercial banks rising interest rate may adversely impact the performance of construction sector in future. In addition, given a high correlation of growth in investment and value addition in the sector, a sharp decline in investment in FY08 suggest slowdown the construction activities going ahead.