HIGH INTEREST RATES PROVE COUNTER PRODUCTIVE

SHAMIM AHMED RIZVI
Feb 25 - Mar 02, 2008

The latest increase in discount rate (from 10 to 10.5 per cent) allowed by the State Bank of Pakistan (SBP) in pursuance of its tightening of monetary policy is being openly criticized in the relevant circles as being unnecessary and unjustified. Expert's feel that the latest increase in the discount rates will achieve objectives as declared by the SBP that it would contain inflation. On the other hand it will prove counterproductive as it would slow down the level of economic activity due to increased lending cost. "It would only add to the fabulous profits which the commercial banks are already making in this country," they maintain.

The tightening of monetary policy was introduced by SBP in the year 2005. In the beginning it was welcomed by all concerned. Further tightening this year with further increasing the discount rate was, however, opposed by the business community as it was likely to hit industrial growth. Federation of Pakistan Chambers of Commerce and Industry expressed concern over the monetary policy saying it is a major cause of slow growth in the industrial sector and widening of economic inequalities. It said the benefits of higher GDP growth rate, building of foreign exchange reserves, accelerated stock market index and record growth of foreign investment had not trickled down to improve the living standards of common man. Simultaneous improvement in macroeconomic indicators and accelerated inflation and poverty had indicated the obstacle in transformation mechanism.

They were of the view that little trickle down effect was observed during the "macroeconomic growth regime" and the tight monetary policy was one of the major hurdles in the way of transferring the benefits of economic growth to the lower segment of the society by enhancing employment-generating activities through promotion of industrial investment.

The Lahore Chambers of Commerce and Industry (LCCI) also strongly reacted to the State Bank of Pakistan's decision to further raising the interest rate on the pretext of controlling fast increasing inflation in the country. In a statement, LCCI President Muhammad Ali Mian Said that the decision would not only increase the cost of doing business in Pakistan but would also destroy the local industry which is already facing shortage of power and gas. Mian said that instead of strengthening the supply chain to control inflation, the State Bank of Pakistan has increased the interest rate which will ultimately affect the whole production process.

The LCCI president said that it is a sorry state of affairs that at a time when the whole industry was already suffering due to high cost of doing business and complaining of being uncompetitive in the global market, the SBP has taken a totally unwise step. He said that the monetary policy announced by the State Bank Governor will not bring any good to the economy but would further deteriorate the situation.

The LCCI president was of the view that imbalances in the economy such as increasing trade deficit, current account deficit, high saving and investment gap, huge government borrowing and persistent high inflation including food inflation would leave a very negative impact on the national economy. Mian said that if the government was serious to promote local business, it would have to look at the monetary policy anew keeping in view the ground realities.

Governor, State Bank of Pakistan Dr. Shamshad Akhtar however, has strongly advocated the tightening of monetary policy to contain the inflationary pressures by rejecting the notion that it will adversely affect the economic growth. "Inflation is a monetary phenomenon and talks of irrelevance of monetary policy tightening to curb the inflation is nothing but irresponsible and absurd statement," central bank Governor contended in response to reservations of business community on the issue.

Talking to members of Federation of Pakistan Chamber of Commerce and Industry (FPCCI) and representatives of business and industry at Federation House, she emphatically defended the monetary policy stance of central bank and even termed the statements and comments of some members opposing the discount rate hike as "allegations and irrelevant."

However, business community people seemingly unconvinced kept raising flaws in monetary policy, which invited a bit of harsh response from, otherwise, soft-spoken SBP Governor. "This tightening of monetary policy is to contain the inflation, which has been brought down with the effective monetary stance since 2005, which otherwise have been in the range of double digit," she stated while talking about the rationale behind the discount rate raise. Also, to reduce the demand pressures and absorb the excessive liquidity in the market, it has become inevitable to further tighten the monetary stance.

One of the highly placed senior economists while talking to this correspondent explained that the basic objective of tightening the monetary policy is to curtail aggregate demand in order to make it consistent to aggregate supply and thereby contain inflation. This policy was needed when it was initiated by the State Bank in 2005 and 2006. It proved effective and during the next year succeeded in curtailing the aggregate demand from 12 to 4 percent by the end of financial year 2006-07.

The other objective of tightening the monetary policy is to control inflation by curtailing aggregate demand. The core inflation has been controlled. The inflation in food prices is the real problem facing Pakistan these days. This is a global phenomenon and cannot be overcome by increasing the interest rates.

The third objective of tightening the monetary policy can be to curtail increasing imports. In our case the basic reason for increased import bill is because of rise in oil prices in the international market. The import of non-oil items has already slowed down. The increase in oil import bill is not because of any abnormal rise in quantity. It is basically because of increased prices. In the year 2005 we imported oil at $63 a barrel which rose to $92 in January 2008.

Continuing he said that now there appears no objective which can be achieved through further tightening the monetary policy. It would rater prove counter productive as

(a) Increased lending rates will further slow down the economic activity and growth resulting in dearth of jobs.

(b) Gap in what the banks are charging from the borrowers and what they are paying to the depositors would further widen.

(c) Cost of Government borrowing from the banks will increase and in turn it would add to fiscal deficit.

The only beneficiaries of this initiative of the state bank would be commercial banks which are already making fabulous profits. They are charging from 12 to 15 per cent interest from their borrowers and paying only 2 to 4 per cent to their depositors.