TIME TO REDUCE THE DISCOUNT RATE

ACCUMULATE THE COURAGE AND DO THE NEEDFUL

SHABBIR H. KAZMI
Nov 23 - 29, 2009

Tight monetary policy has not really been effective. It has not helped in containing inflation but certainly marred fresh investment and eroded competitiveness of the local manufacturers. Above all the failure of the government in containing budget deficit and resorting to excessive borrowing has also added to the debt servicing.

It is feared that the country has been trapped in a vicious cycle forcing it to borrow more for discharging the liabilities. In the absence of plausible plans for boosting GDP growth rate, producing exportable surplus and restoring eroding competitiveness, debt serving is likely to become unsustainable.

The policy planers, living under the shadow of multilateral lenders have not accepted the fact that inflation in Pakistan is cost pushed and the attempts keeping interest rate high, raising utility charges and to withdrawing subsidies will plunge the country deeper into the problems.

Every time prior to the announcement of the Monetary Policy Statement, the experts toeing the IMF line start ringing alarms that any significant reduction in interest rate would let the inflation jinni go out of control. One can only ask; have you ever been able to control the monster called inflation?

With the declining trend in the internal prices of crude oil and commodities, inflation has virtually reduced to single digit. High prices of eatables in the country are due to interruption in supply chain and disruption in market mechanism. Prices of wheat flour and sugar have gone up due to porous boarders and disruption in supply chain. Last year black marketing of urea was rampant and farmers were forced to pay higher price, despite the government paying billions of rupees in subsidies. This year sugar prices skyrocketed despite the Supreme Court orders to ensure its availability at Rs40/kg.

Couple of weeks back probability of reduction in discount rate by 200 basis points deemed probable. This ushered buying spree in the equities market and influx of foreign funds also increased. When stage was set for reducing the interest rate, pressure started mounting on Pakistan for increasing electricity and gas tariffs. The suggested substantial increase is bound to result in steep rise in inflation and make the critics say since inflation rate is high in the country, discount rate cut should not be allowed.

Even prior to that IMF installed critics had started saying that any substantial decrease in discount rate would let loose inflation. Now it is said that keeping in view the ground realities the central bank should preferably reduce the discount rate by 50 basis points and the attempt to reduce it by 100 basis points would prove counterproductive. There is also a minority which has always resisted reduction in discount rate. It is not understood whose line is toed by this group.

It may be worth reminding that during nineties when interest rate was hovering around 25 percent, many projects were established by the private sector. The result was most of them already closed down their operations after incurring huge losses and the public sector financial institutions extending credit to these entities were merged into other institution after becoming virtually insolvent. These institutions were PICIC, IDBP, ICP and NDFC.

One of the key factors responsible for rising delinquency and NPLs is also the unsustainable debt servicing. A cursory look at the annual accounts of listed companies belonging to textiles, sugar and cement industries reveals that financial cost paid by many of the units belonging to these sector ranges from 50 to 80 per cent of the gross profit. However, blame for the prevailing state of affairs also goes to the financial institutions and the central bank.

Lately, there was news of arrest of sponsors of Haris Steel Mill accused of acquiring funds from Bank of Punjab fraudulently. This is not the only case. A little deeper probe by the central bank can unearth dozens of similar financial scams.

Last case which also hit the headlines of newspapers was Mohib Textile Mills. In this case nearly three dozen financial institutions were defrauded through a number of cross leases. In this particular case a number of local financial institutions had lent money to the sponsors a little recklessly.

An attempt was made in the past whereby an entity acquired the 'bad loans' of commercial banks. A similar arrangement is proposed once again. This may help many financial institutions to clean their slates for the time being but does not provide a sustainable solution.

As long as the country continues to suffer from contentious diseases like circular debt the outlook for the entities and the financial institutions would continue to suffer. Lately, the government issued TFCs worth nearly Rs200 billion to ease the burden in circular debt but the burden of another Rs80 billion propped within couple of months.

After the latest auction of Treasury Bills, indicating reduction in cutoff yields the probability of up to 100 basis points has got some credence. However, it is difficult to give any forecast because of the difference in mindset of professionals sitting in the central banks/ministry of finance and the elected representatives.

If the elected representatives are not ready to act prudently, the central bank must assert it self. Under influence of political agenda the central bank is marring its autonomous stature. Politicians may come and go but the sanctity of the institutions must prevail over.

This time the governor SBP must be supported by all to reduce the discount rate by 200 basis points. If reduction of such a magnitude is not brought this time it will not be possible in the future. Accumulate the courage and do the needful.