GROWTH'S DESTRUCTIVE HIGH INTEREST RATE REGIME
SHAMSUL GHANI (email@example.com)
Nov 23 - 29, 2009
The SBP interest rate is the rate used for its lending to banks under repurchase (Repo) transactions. The rate has an explicit cost expressed in numeric terms. It has also an implicit cost conveyed through an implied yet well-pronounced message. When interest rate is increased, the banks take it as a signal that the SBP intends to control credit and money supply besides increasing market interest rate. With every alteration in the rate, the inter bank borrowing rate KIBOR is also altered, usually in direct proportion.
The banks' lending interest rate, which has been linked to KIBOR, is also adjusted accordingly. The SBP benchmark interest rate, presently standing at 13 percent, has been altered as many as 40 times since 1956. It was scaled up 24 times, as against 16 times it was scaled down. The lowest rate had been 3 per cent during the period from 01-01-56 to 14-05-59 while the highest rate had been 20 per cent during the period from 13-11-96 to 17-06-97. We might see another cut of 100 bps in the coming weeks when SBP makes a review of its monitory policy.
Any alteration in interest rate brings with it the possibility of significant changes in macroeconomic indicators of the economy. A lower interest rate might stimulate economic growth by loosening up the money supply, which in turn increases aggregate demand leading to higher consumption and investment.
Alternatively, a higher interest rate might result in the drying up of liquidity inducing recessionary changes in the economy. An upward change in interest rate may be required to control inflation. But, reliance on a high interest rate to control inflation may be fraught with risks. The central bank cannot simultaneously set both the interest rate and money supply levels because it has no control over demand-for-money function. It cannot accurately forecast demand for money at a certain interest rate. The problem with the focusing on interest rate is that the growth rate of money and inflation often tend to increase. A moderate money growth is the only option to avoid inflation over the long run. State Bank's interest rate hike aimed at controlling credit and money supply has so far failed to produce desirable results as our inflation rate ñ to make an understatement - remains the highest in the region. To be fair, State Bank policies cannot be effective in isolation. Government support especially on administrative side is also required.
Inflation and unemployment are the ultimate targets of central bank policy. Interest rate and the rate of growth of money and credit are the intermediate targets, which the central bank can hit. Inflation targeting is widely popular with the central banks to achieve long-term objective of price stability. The disadvantage of this approach is however, quite considerable as it restrains central bank's ability to control fluctuating output and employment levels. In the event of an adverse supply shock, which raises prices and reduces output, inflation targeting may force the central bank to check money supply at a time when the economy is in recession.
At a time when the world economy is struggling to come out of the trauma of recent global economic recession, our high inflation and interest rates are going to do more harm than any good to our already depressed economy. Our swiftly depreciated rupee has further stifled the growth as high costs of import rule out the possibility of any worthwhile capital formation, which is so badly needed to boost our underperforming LSM sector.
Our economy during FY-03 to FY-07 grew at an average rate of 7.3 per cent. This was the period when the interest rate was a bit competitive with reference to the regional interest rates. During the high interest rate period, our GDP first shrank to 4.1 per cent in FY-08 and then came down to just two per cent in FY-09.
The forecasts for FY-10 appear to be mixed - from one to three and a half percent. Historical economic data suggest that there is a direct relationship between the interest rate and the GDP. If the GDP target of more than three percent for the coming two years has to be achieved we will need a reduction of at least 300 basis points in the interest rate by the close of FY-10 followed by another 200 bps cut during the FY-11. This will introduce some element of reason in our benchmark interest rate, though it will still be the highest in the region.
WORLD INTEREST RATES
COUNTRY / CENTRAL BANK CURRENT INTEREST RATE % PREVIOUS INTEREST RATE % LAST CHANGE INTRODUCED MAJOR CENTRAL BANKS Bank of Canada 0.25 0.5 Apr 21, 2009 Bank of England 0.5 1.0 Mar 05, 2009 Bank of Japan 0.1 0.3 Dec 19, 2008 European Central Bank 1.0 May 07, 2009 Federal Reserve 0.25 1.0 Dec 16, 2008 Swiss National Bank 0.25 0.5 Mar 12, 2009 The Reserve Bank of Australia 3.5 3.25 Nov 03, 2009 ASIA PACIFIC COUNTRIES China 5.31 5.58 Dec 22, 2008 Hong Kong 0.5 1.5 Dec 17, 2008 India 4.75 5.0 Apr 21, 2009 Korea, Republic of 2.0 3.0 Feb 16, 2009 New Zealand 2.5 3.0 Apr 29, 2009 Pakistan 13.0 14.0 Aug 17, 2009 Taiwan 1.25 1.5 Feb 19, 2009 OTHER COUNTRIES Brazil 8.75 9.25 Jul 31, 2009 Egypt 8.25 8.5 Sep 22, 2009 South Africa 7.0 7.5 Aug 13, 2009 Turkey 6.75 7.25 Oct 16, 2009