MONTHLY DECLINING CORE INFLATION BRIGHTENS POSSIBLE INTEREST-RATE CUT
Mar 30 - Apr 05, 2009
LAHORE: Increasing raw material/commodity prices, rising interest rates, high inflation, trade deficit, declining forex reserves, deteriorating law & order situation and uncertain political situation not only caused negative impacts on the countryís economy but also hit hard the common persons who are finding it difficult with each passing day to make their both ends meet.
Majority of business persons particularly those engaged with textile sector are deeply perturbed over high interest rate in the country. Pakistan is among few countries where the interest rate is too high, which is posing manifold challenges to develop competitive business environment, textile industrialists told PAGE.
On one hand, we are facing non-conducive business environment, while there is a surge in cost of doing business on the other, they said. This led to more problems for business persons. Inconsistent government policies and increased levies and taxes hit hard to local automobile sales. The number of auto loans per bank has gone down considerably over the past one year while it has had a direct impact on the consumers whose purchasing powers have decreased and their trembled confidence to the local economy put purchase decisions on hold.
Inflation, though declining, remains high at 20.5% in January this year, as measured by the Consumer Price Index, compared with a three-decade high of 25% last October, and according to the latest government forecast may decline to only a 20% annual rate by the end June 2009, against an earlier projected target of 12%.
Core inflation slightly increased to 18.9% in January from 18.8% in December. The central bank in its monetary-policy statement on January 31 kept its benchmark interest rate unchanged at 15%. The decline in oil prices and stable food prices have created a ray of hope for an interest-rate cut by the central bank, analysts believe.
The State Bank has increased its benchmark interest rate five times in the past 18 months to tame core inflation (that is, excluding food and energy), but according to analysts, the decision to maintain present high rates clearly indicated that this policy had not yielded the required results.
Leading business persons also criticized the SBP's stance. "The government's stance not to reduce the interest rate was illogical, whereas lack of new developments in the policy also did not help fight the economic woes in any way," a leading industrialist Mian Faraz Alam said.
He added textile is not the only sector to be affected by the phenomenon of high interest rate. Moreover, reports are pouring in that the International Monetary Fund has agreed to allow reduction in discount rate that would lead to overall downward revision of interest rates by the banking and finance sector.
According to reports, the IMF has agreed on discount rate cut in the next quarter's monetary policy to be unveiled in April provided core inflation continues to decline.
"There still exists a four per cent gap between the discount rate, which stands at 15 percent, and core inflation, which hovers at 19 per cent. However, if the decline in core inflation on monthly basis continues, then in April the government would reduce the discount rate accordingly," Adviser to Prime Minister on Finance Shaukat Tarin informed during a press briefing after holding talks with the IMF in Dubai.
"The Fund always pursues a policy to raise the discount rate under its programme, but Pakistan has managed to convince the IMF for a cut in the rate keeping in view the reduction in core inflation on monthly basis," a senior official said.
A broker in Lahore Stock Market said, "We have been highlighting the trend reversal of interest rates that is due to impact the bourses positively in the coming six months."
He said the liquidity preference suggests that there is a slump in the demand for money, which currently pertains to demand for speculative purposes but a decline in transactionary demand would not be a distant possibility given the persistent hike in interest rates.
It seems that the economy is moving towards a recessionary phase and interest rate maneuvering would be a key policy shift that would keep the economic engine on track, he opined. Before a change in interest rate is made, there is a need to estimate the capacity of the overall corporate sector to inhale the resultant impact, he argued.
He said depending on each sector's financial leverage and volume of debt used to transact business increase in interest rates hurts the business activities or a decrease in interest rates facilitates a positive change. Certain sectors of the economy seem to be highly leveraged, as their assets are financed by debt rather than own equity, he added.
He said since the private businesses also form part of the overall economy, one must consider the listed sector for analyzing economic impact of raising interest rates, and each sector's leverage ratio may be judged on the basis of its size and whether such sector has a greater or lesser proportion of private entities.
With currency depreciation creating room for the textile sector in particular by the end of this fiscal, perhaps due to high imports to export ratio and increasing trade deficit it seems that there is a need to bring down interest rates in the wake of 'controllable inflation'. This would boost this sector's earnings, besides making provision for capacity enhancement and technology upgradation, analysts said. In addition, the declining exports and the bane of electricity generation is a cause of concern for the country's business, they opined.
With a decrease in interest rates, there will be a possibility of increase in economy's production, with financial sector's performance sliding due to lowering of interest rates.