INTEREST RATE IN PAKISTAN

S.M.ABBAS ZAIDI,
Research Analyst
, PAGE
Aug
 03 - 09, 2009

An interest rate is the price a borrower pays for the use of money they do not own. Interest rate is normally expressed as a percentage rate over the period of one year. Interest rate is also a vital tool of monetary policy and is used to control variables like investment, inflation, and unemployment.

In Pakistan, state bank is responsible for regulating the interest rate. At present, the State bank's interest rate stands at 14%, which is highest in the region.

State Bank of Pakistan is likely to cut its discount rate (interest rate) to 13 or 12.5% in the next monetary policy announcement.

The present government may support decreased interest rate to restore the confidence of investors who are already shying away from the country because of poor security, militancy in the northwest region, and decrepit power infrastructure.

Pakistan was forced to seek a $7.6bn bailout from the International Monetary Fund in November and now it has requested additional $4bn credit from the Washington-based lender.

State bank is due to release the quarterly monetary policy statement on August 15, after the announcement was delayed from the previously scheduled date of July 25. Earlier, SBP in April cut the benchmark rate one-percentage point to 14% first time after raising the rate five percent during last one year.

REGIONAL INTEREST RATES (%)

COUNTRIES END07 END08 LATEST
Korea 5.00 3.00 3.00
Thailand 3.25 2.75 2.0
Philippines 5.25 5.5 -
Taiwan 3.375 2.0 1.25
Indonesia 8.00 9.25 8.75
India 7.75 6.5 4.75
China 7.47 5.31 5.31
Turkey - 8.75 8.25
Pakistan 10.00 15:00 14:00
Various Sources

IMF PRESSURE

There has been a pressure from the IMF to wait for July inflation numbers. The IMF probably wants the central bank to be conservative in a rate cut and the central bank probably wants the IMF to first release the third loan installment.

The IMF may also approve an installment of $840 million in August. Policy makers last raised borrowing costs by 2 percentage points on Nov 12, the fourth increase in 2008 as part of conditions of the IMF loan, and to curb inflation that reached a 30-year high. Consumer prices rose 13.13% in June from a year earlier, the slowest pace in 16 months. Easing inflation gives the central bank room to cut interest rate.

Pakistan was forced to turn to the IMF for a rescue package in November to avoid defaulting on its debt, after the country's foreign exchange reserves shrunk 75% in a year to $3.5bn and the current account deficit widened to a record.

TWIN DEFICITS

The twin deficits of current account and budget are under control and therefore there is no reason the central bank should not reduce interest rate. Lowering rates might trigger economic activity, as investors are concerned about high cost of borrowing. Pakistan's economy has been deteriorating over the past two years because of political instability and poor law & order situation. The global recession has eroded exports and investment and Taliban insurgents have launched terrorist attacks in response to an intensified military campaign against extremists.

The $146bn economy may expand as little as 0.8% in the fiscal year to June 2010, the weakest pace since 1952. The government estimates growth of 3.3%. Continued inflationary pressures, a weakening rupee, and IMF pressure are likely to keep the central bank conservative as regards to monetary easing. Pakistan's rupee plunged 22% last year and the benchmark stock index tumbled 58% as investors withdrew funds from riskier emerging markets amid a downturn in the global economy.

CURRENT SITUATION

INTEREST RATES IN PAKISTAN

MONTHS/ YEAR RATES (%)
7-Jun-01 14
19-Jul-01 13
17-Aug-01 12
20-Oct-01 10
23-Jan-02 9
18-Nov-02 7.5
11-Apr-05 9
29-Jul-06 9.5
1-Aug-07 10
31-Jan-08 10.5
23-May-08 12
30-Jul-08 13
13-Nov-08 15
Apr-09 14
Source: SBP

In April 2009, the State Bank of Pakistan had cut discount rate by 100 'basis' points, to 14%. The Central bank, however, kept unchanged the Cash Reserve Requirement (CRR) and Statutory Liquidity Requirement. The decreasing trend in inflation now appeared robust as CPI inflation (YoY) has come down to 18% from the peak of 25.3% in Aug 2008. Due to decline in the pace of inflation, bank depositors are getting better profit rates on their deposits, as real rates of return on deposits would start increasing once the inflation declines further during the upcoming months. Therefore, real rates of return would turn into positive digits. The cut in KIBOR in future will also help the business and industrial sector to achieve better prospects of growth and development.

Reduced domestic demand pressure, as evident in shrinking twin deficits, are expected to narrow the output gap and reduce inflation. However, supply shocks such as power shortages and worsening law and order situation may delay the eventual fall in inflation. Weak performance of commodity producing sector, services sector is also likely to show a weaker growth in FY-09 than the target of 6.1 % for the same fiscal. The dismal performance of Large Scale Manufacturing (LSM) in FY-09 with negative growth of 8% and weaker target growth of agriculture sector points towards the weaker real economic activities of commodity producing sector for FY-09. However, LSM sector growth, in particular, the performance of export driven industries (particularly, textiles) has been negatively affected amid energy outages, deteriorating law and order situation.

CONCLUSION

Pakistan may cut interest rates by as much as a third as poor law & order weakens an already deteriorating economy. The State Bank of Pakistan may lower its policy discount rate by between 400 and 450 basis points from 14% by the next month to help counter-entrenched recessionary inclinations. Lowering rates may revise economic activity as investors are concerned about political instability and governance.