INTEREST RATE ISSUE

SHABBIR H. KAZMI
Oct 26 - Nov 01, 2009

The economic managers of Pakistan can be divided into two groups. One suggests maintaining higher interest for containing inflation, the other demands substantial cut in prime interest rate for accelerating GDP rate in the country.

However, the first group also towing the IMF line has dominated the other group. The net result is that the inflation rate has no been contained but country is plunging deeper into economic chaos.

While the competitiveness of the local manufacturers is eroding, failure in creating new productive facilities is having its adverse impact on the economy.

To begin with, one point must be kept in mind that inflation in Pakistan is not demands driven but cost pushed. Therefore, the sole attempt of keeping interest rate high just cannot help in containing inflation. The adverse impact of keeping interest rate high is hike in cost of doing business, eroding purchasing power, failure in creating new productive facilities, shrinking job opportunities and above all declining revenue collection of the government.

The attempts to impose new taxes or increase rates of prevailing taxes are also proving counterproductive.

Since Pakistan has once again chosen to approach the IMF for bail out and also insisting on enhancing support, new conditions are being attached. One of these links interest rate movement with the rate of inflation.

The recent cut in discount rate has been termed 'too little but too late' by some analysts. However, the followers of IMF policies are still insisting that the central bank should have opted for further increase in discount rate.

In Pakistan many industries, textile in particular, suffer from excessive borrowing. The review of profit and loss accounts of listed textile companies shows that in case of some companies' up to 70% of gross profit goes towards financial cost and entities often end up posting loss. The sector has often pleaded moratorium on debt servicing. However, experts are of the opinion that unless their basic business model is changed the reduction in interest rate alone cannot help in improving their financial health.

According to some analysts most of these companies are part of one or another group. The sponsors of such companies have raised equity of various companies through borrowing. In the past many of the public limited companies were extending interest free loans to associate undertakings. As the laws became stringent instead of extending credit these entities started investing in the shares of associate companies. Since all such investments are made from borrowed money financial cost often goes out of proportion. In fact the high financial cost just cannot be justified. The situation has prevailed only because regulators have hardly bothered to find reasons for awfully high financial cost. It is also necessary to highlight that textile companies have always resisted moves for cost audit.

There is still an urgent need to cut interest rate, not to facilitate fresh credit off take by the existing borrowers but for creating new productive facilities. It goes without saying that to accelerate GDP growth rate the country needs creation of new productive facilities as well as improving production and productivity of the existing industries.

It is also pertinent to mention that higher duty rates on plant and machinery and raw material necessitate borrowing from the financial institutions. Many of the sponsors prefer to borrow from bank rather than mobilizing funds through capital market, either through flotation of shares or term finance certificates.

One of the reasons for opting to borrow from banks is rather less stringent credit appraisal policies of the banks as well as cost. Flotation of shares and/or TFCs at times proves more expensive.

The government policy of borrowing from the banks has also disrupted market dynamics. Contrary to the global practices government papers in Pakistan have always offered higher returns. This has also encouraged the financial institutions to invest in government securities rather than corporate bonds. The data show that over the last couple of years persistent hike in yields of treasury bills has facilitated the banks to invest in government securities rather than making at attempt to extend credit to the private sector.

According to some analysts one of the reasons of higher interest rate is spread of around 7.5%. However, this point is often refuted by the bankers. They say the spread is not as high as 7.5% for all the banks. The perception has been created because of 'big five'. These banks not only have extensive outreach but often enjoy 'cost free' deposits. As against this the average spread of other banks is not as high as this. Besides, banks are in the process of deployment of new technologies and expansion of branch network. This is a long drawn process but returns start coming with time lag.

It has become imperative that the economic managers convince the IMF that reduction in interest rate is necessary for facilitating creation of new productive facilities. Though, some of he critics may not like the country needs to follow 'SRO based lending'. The policy of the central bank regarding lending to agriculture sector has yielded results. It is on record that at one point some of the commercial banks preferred to pay penalty rather than extending credit to farmers.

This type of lending will only be possible once the policy planners do long term planning and also identify priority areas for investment. Efforts should also be made to create DFIs and investment banks and revive NBFCs to free the commercial banks from lending medium and long term funds.