INVESTMENTS SLOW ON HIGH INTEREST RATE
Aug 8 - 14, 2011
Pakistan is one of the countries where the interest rate is highest in the world. High interest rate makes borrowing costly and thus discouraging firms to invest and consumers to spend.
The intention behind keeping high interest rate was to check the rising inflation but desired results were not achieved as inflation is still high while investment climate is damp for last few years.
This is quite evident from the diminishing imports of machinery and equipment and reduction in the industrial output for the domestic and foreign markets.
The cost of doing business is already too high in the country and even local investors are setting up their ventures abroad, what to say about foreign investment?
High interest rate as a tool to fight inflation is a double-edged sword. The idea is to suck the excess liquidity off the money markets. In fact, the central bank had started pursuing a policy of tightening the markets well within the regime. And, the policy has served its purpose as well. The problem, however, is that excess in money supply is but one cause of inflation.
Investment in roads, transport and communication sector can help firms reduce costs and expand production. Without necessary infrastructure, it can be difficult for firms to be competitive in the international markets. The poor infrastructure is often a factor holding back some developing economies.
As per statistics made available to PAGE, gross fixed capital formation in the manufacturing sector shrank by just above 16 per cent so far during the current financial year. This is over and above the 8.5 per cent drop in investment in the manufacturing recorded last year.
Investment in the large-scale manufacturing has declined by an unprecedented 32 per cent. This compares with 17 per cent contraction in investment by large manufacturers last year. The slump in investment is attributed to energy crunch, security concerns, high borrowing cost, and political instability.
Overall private investment has steadily reduced with gross fixed capital formation recording a contraction (in terms of constant market prices 1999/00) of 3.1 per cent during this fiscal over and above a decrease of 5.7 per cent last year.
The contraction in investment shows the restricted access of the private sector to credit because of rising government borrowings for financing its budget and increasing cost of credit.
Experts told PAGE that investors are scared because of deteriorating security conditions as well as uncertain and challenging economic environment.
They urged the government to focus on issues like investor-friendly policy framework, economic and political stability, and security of investment.
The investment-to-GDP (gross domestic product) ratio dropped to below 17 per cent last financial year mainly because of decreasing private (domestic and foreign) investment after peaking to above 22 per cent in the mid 2000s, they said, adding "manufacturing sector has been hit hardest by the declining investment. Following the large-scale manufacturing, gross fixed capital formation in construction has contracted by 21 per cent, transport, and communication by 11 per cent and financial institutions by 10 per cent."
Experts believe that the falling investment in the industrial manufacturing is not good for the long-term economic prospects.
Investment is crucial to raise the production capacity. The government must take steps to encourage private investment to kick-start growth. Businesspersons are frustrated and the government needs to involve them in economic policy-making process to restore their confidence, they insisted.
It may be noted that India's investment-to-GDP ratio, for example, hovered around 30 to 37 per cent of GDP in the 2000s.
Similarly, China sustained an investment rate in the range of 40 to 44 per cent, Vietnam in the range of 30 to 42 per cent, Kazakhstan in the range of 27 to 32 per cent. These countries have sustained high growth rate.
Experts believe that private investment will revive once the macroeconomic imbalances are taken care of. They advised the political parties to agree on a minimum economic agenda to "give a clear direction" to the businesses and to put the investors' fears of policy reversals at rest.
They advised the government to engage itself in an active dialogue with industry and take effective measures to end energy shortages and improve security to boost the investor confidence.
Cut in credit cost will not only spur investment but also help curb inflation and slash the government's budgetary deficit and reduce its borrowing needs, they added.
According to them, high interest rate is the main determinant of investment. The high credit cost is stalling investment plans. High interest rate is the root cause of all economic difficulties and stalling revival of the economy and private investment.
Decline in interest rate to single digit will immediately encourage massive private investment in the economy, increase productivity, make exports competitive, reduce the government's domestic debt servicing obligations apart from curbing inflation and escalating economic recovery, they pointed out.
Traders and industrialists were of the view that a reduction in the interest rate to single digit was need of the hour. They further said that the interest rate was highest in Pakistan while exporters had been rendered uncompetitive in the global market due to massive overheads.