Feb 28 - Mar 6, 20

Not that the State Bank has earned the dubious distinction of being a slow learner, it has almost refused to be a learner at all. We all know that a high interest rate controls inflation in the short term only after which its role becomes that of a catalyst for inflationary buildup.

Inflation targeting is widely popular with the central banks to achieve long-term objective of price stability. The disadvantage of this approach is however, quite considerable as it restrains central bank's capability to control fluctuating output and employment levels. In the event of an adverse supply shock, which raises prices and reduces output, inflation targeting may force the central bank to check money supply at a time when the economy is in recession. This is exactly what happened in our case. SBP had to intervene with successive rate hikes at a time when the economy had already taken a downturn due partly to global economic factors and partly to our home-brewed political and financial crises, which saw massive capital outflow. Under the then prevailing circumstances, the SBP thinking was quite clear that even if the interest rate increase adversely affected growth in the short term, the primary concern would remain the check on inflation. Its persistence with an unusually high policy rate, however, remains enigmatic. Perhaps it's a way to shield its weak autonomous position.

The source of inflation in our case is not high consumer spending rather it is high government borrowing both from SBP and the banking system. Since SBP is not in a position to exercise its authority over government functionaries to curtail their lavish spending, it creates a smoke screen of high policy rate to give an impression that it really means business, the business of achieving price stability.

The ongoing global and regional interest rates are in the single digit and in some cases close to the zero level. Fortunately, the world interest rate reporting agencies do not include Pakistan in their tables of comparison. And, that saves us the humiliation of being an economy from another planet. Let's make an attempt to compare our interest and inflation rates with those prevailing in some of the world and regional economies.


Pakistan 14% 14.2% Taiwan 1.63% 1.25%
India 6.5% 8.2% Malaysia 2.75% 2.4%
China 6.06% 4.9% Vietnam 11% 12.3%
Sri Lanka 8.5% 6.8% Australia 4.75% 2.7%
Hong Kong 0.5% 3.8% United States 0.25% 1.6%
South Korea 2.25% 3% UK 0.5% 3.7%
Japan 0.1% 0.00% Canada 1% 2.3%

Vietnam, the only regional economy with interest and inflation rates in double digits, has still to go quite some distance to challenge our leading position, as far as the said two economic indicators are concerned. Apart from these two unenviable resemblances, Vietnam economy - after shifting its focus from a highly-centralized economy to a socialist-free-market economy - has nothing much in common when compared to our economy. It is a fast growing Asian economy tipped to become the fastest growing economy by 2025 with a potential to grow by 10 per cent annually. Coming back to the subject, it will be observed that there is an unmistakable relationship between the interest and inflation rates in an economy. In 79 per cent of the cases mentioned in the table, the difference between the two rates is less than two percentage points; and in 43 per cent of the cases the rate of inflation is less than the rate of interest. Keeping with the regional trend, a hypothetical policy rate of around eight per cent could have restricted our inflation to a single digit.

Efforts to control inflation through policy rate hike have been successful nowhere. The Reserve Bank of India recently failed to control inflation through several policy rate hikes. The root cause, as reported by Anand Kumar from Mumbai, was a stiff rise in food prices that saw food inflation climb up to 15.6 per cent. Food price hikes, in fact, ensued from the mismanagement in food supply chain. In our case too, the problem lies somewhere else. Government's high borrowings, energy sector's inter-corporate debt, and public sector organizations' insatiable appetite for loss making are the core issues that cannot be tackled by mindlessly hiking the policy rate and maintaining it at a damaging level. Instead of destroying the economy by persisting with the failed strategy of tight monetary policy, SBP should have the nerve to ask the government to enforce fiscal discipline. This is what the Sri Lankan economy has witnessed during the recent times.

According to the central bank of Sri Lanka: "Certain recently implemented fiscal measures, such as the duty waiver granted for customs import duty on petrol and the reduction in taxes on importation of milk powder would reduce the upward price pressures arising from adverse international commodity prices." Can we think of our government taking such highly important fiscal measures to reduce inflation?

Besides stifling the economy, a high interest rate puts immense pressure on domestic currency. High cost of borrowing increases the cost of input, which in turn makes our exports uncompetitive in the international markets. With this, the dollar inflow is restricted and external account imbalances are created which are corrected either through lesser imports, leading to low capital formation, or by exporting our bread and butter - wheat, rice, meat, fish, fruits, and vegetables - leaving our poor masses to starve. The recent current account respite is short lived as international oil price hikes in the wake of Middle East political crises coupled with the higher debt maturities that lie ahead threaten this temporary external account relief. The recent improvement in the foreign portfolio investment is also not to be counted on as this short-term dollar inflow can go as fast as it comes. Services sector and foreign remittances are holding the economic fort since quite some time while the real sector economy has been systematically destroyed. Will someone ask the state bank to take its foot off the brake pedal?