HIGH INTEREST RATE WILL HURT NEW INVESTMENTS
Jan 26 - Feb 01, 2009
Nobody would think it could get more bleak --- the collapse of securitization and shadow banking, a foreclosure melt-up, failing banks, the blackest consumer outlook in last three decades, energy commodities near all-time-high, shrinking margins driving the year of the corporate defaults, sharply rising unemployment, over levered individual cash flow under intense pressure all the way up the scale, financial troubles spreading globally through conduits of globalized finance & trade --- what more could go wrong? Yes, there is another factor driving the global economies even worse, and that is ever-rising interest rates over the previous recent years. It is being assumed globally that the rising interest rates may hurt new investments. In fact, investors seem to be concerned whether high inflation would mean that consumer demand would slow down, whether high interest mean that consumers could afford to buy or purchase what they want to purchase.
Escalating interest rates have various economic effects, such as increased cost of borrowings, increase in mortgage interest payments and discouraging consumer and business confidence. The impact of this rise is in different ways on people, along with other factors of various economies. As far as Pakistan's economy is concerned, interest rate hike is making dent on almost every sector, along with making the individual's life miserable. This resulted in (i) decline in credit off-take, (ii) impediment to auto sector growth, (iii) block in new investment and (iv) slackness in real estate sector. SBP, as per its interim Monitory Policy in May 2008, raised the discount rate by a hefty 150bps to 12%. This was the part of SBP's two-pronged policy to reduce the excessive liquidity prevailing in the system ñ to curtail core inflation. Further, tightening took place in 1HFY09 monitory policy when the central bank increased the discount rate by another 100 basis points to 13%, which was further moved up to 15% in November 2008 once again, though this time the upward revision was done on the basis of a pre-condition by International Monetary Fund (IMF) to control the overall credit demand and to control the burgeoning inflation.
Interest rates remained high in calendar year 2008 due to successive increases in the benchmark discount rate by the central bank. As per the latest data, the lending rates of banks averaged around 12.12% till October 08 as compared to 11.30% in CY07. On the other hand, cost of borrowing averaged around 4.91% as against 4.0%. The major hike in deposit rates was observed in June 08 when SBP placed the minimum requirements of 5% return on saving accounts. This step increased the interest expense of banks along with shrinkage of interest rate spreads. On the advances side, despite skyrocketing lending rates, the credit off-take managed to grow, though at a slower pace compared to previous years. Public sector borrowing continued unabated (except for negative growth in July) to finance budgetary expenditures and Public Sector Enterprises' operations. Moreover, private sector demand also grew slightly; however, remained nominal in last recent months. A number of factors were attributable to the rise in private sector's credit demand: (1) scarcity of non-banking sources of financing like TFCs and Sukuk bonds, (2) working capital requirements of Independent Power Projects (IPPs) and Oil Marketing Companies (OMCs) continued to rise and (3) regulatory measures taken by SBP to hold the foreign exchange market pressures evident particularly in July to September period. Temporary suspension of forward cover against all types of importers in July 2008 led to higher demand for rupee financing by a few importers to hedge their exchange rate exposure. The continued increase in discount rate also resulted in slump in net investments in the market, as companies showed low participation in government papers.
Thanks to high interest rates auto-industry also witnessed a slump. The hike in interest rates has made auto financing more expensive and less attractive for borrowers. Auto-financing was a major source of car sales and the resultant growth of the automobile industry and its vendors. Banks put the brakes on auto-financing during last fiscal year after incurring major losses owing to repeated defaults. The domestic automobile sector has been passing through a difficult time where the dynamics of the industry are turning out to be unfavorable from both demand and cost sides.
Interest rates are unlikely to come down to the original shape like a few years back. In fact, a further increase is expected in discount rate during the second half of the ongoing financial year. We don't see any easing of monitory policy as long as high inflation persists. Thus, people have to understand that there is no chance of this chaos getting corrected, and that they will have to keep there breaths to face difficult times at least in the short run.