BENCHMARK RATE NEEDS A FASTER REVERSAL

SHAMSUL GHANI
(feedback@pgeconomist.com)
Aug 8 - 14, 2011

Better late than never is fine but what about the time that was lost in deciding that we had chosen a wrong path. And, are we really interested in moving ahead on the path we have just discovered?

State Bank needs to act faster to remove the 'regional pariah' label from Pakistan's economy. It needs to shed the excessive 500-basis-point fat from the body of benchmark interest rate in quick successive cuts.

Let the interest rate stabilize around eight percent. We should be bold enough to have courage to live with the regional economies. Inflation is just not a passive force to be controlled by bookish economic decisions like raising the interest rate and then layback.

Our inflation has to do much with the administrative side of governance. Economically, it is the outcome of grave inequality of incomes. Those awash with money know no bounds to consumer spending.

The shopping malls, the junk food and exotic cuisine outlets, the 24/7 TV shows on culinary art and expertise, all are proof to the inequality of incomes and reason behind the rising prices. Those waiting on the sidelines for at least a single meal (a day) keep growing in numbers year-on-year. From the time the IMF came to our rescue in November 2008, the number of those living on $1.25 and less has literally doubled. If their policies of a high interest rate could not check the incidence of poverty, the SBP bosses should long have realized that there was something wrong with their understanding of Pakistan's inflation.

High interest policy tool is used by some economies to control inflation, which is confronted during the course of higher growth and increasing per capita income. China and India are the examples. Do we have any semblance to these economies? Another example is Brazil with an interest rate of 12.5 percent. Here are some of the economic indicators of Brazil: economic rank 7th; nominal GDP $2.09 trillion; GDP per capita $10,471; current inflation 6.3 percent against 12.5 percent in 2002; population below poverty line 15.5 percent; exports $202 billion; imports $187 billion. Do we have any thing in common with Brazil, on economic front?

Its policy of a high interest rate has obviously been successful as the current inflation rate has almost halved from 12.5 percent in 2002. The most worrisome problem of its economy has been its fast appreciating currency.

Neither we have been able to control inflation nor have we succeeded in checking the rupee deprecation. We have spent three years in knowing that we were wrong. And who knows that we really know that we have been wrong? To know it, we will have to wait and see how fast the interest rate is brought down to a realistic level.

The recent cut in policy key rate raises hope of the change of perception on SBP governance level. The outgoing governor is reported to have differences with the government on two accounts: the excessive government borrowings both from SBP and the banking system, and government's desire to bring the interest rate down.

If the report is correct, the outgoing governor is not going to have much of the sympathies of the analysts as he is fighting for two opposite causes. Highly excessive government borrowing must stop; no one is going to argue that. But, blocking government move to bring down the interest rate is certainly not something for which the relieved governor should claim credit.

To hold the interest rate at an unrealistically high level just to forestall the possibility of political misuse of credit was simply na´ve, to say the least. The rate was to be brought down in bits and pieces to systematically rebuild the businesspersons and investor confidence. Those bent on to misuse credit never wait for the interest rate to come down. They do it any way, as they do not intend to return bank's money.

It is the SBP and banking system policy frameworks, and not a high policy rate, that are used to check misuse of credit. We cannot put lid on the economy just to allay our perceived fears of corruption, as corruption control does not fall under the ambit of monetary policy.

Corruption is deeply ingrained in our society. It has strengthened its roots during the course of 64 years of intermittent autocratic and democratic rules. Its incidence can only be reduced through genuine economic growth that guarantees jobs and incomes.

Low-interest-rate economy has certain drawbacks that could be overcome through effective monetary, fiscal, and administrative controls. We have seen it succeeding during 2002-07.

CURRENT INTEREST RATE IN THE WORLD

COUNTRY INTEREST RATE % DATE SINCE COUNTRY INTEREST RATE % DATE SINCE
Australia 4.75 02-11-10 Mexico 4.5 17-07-10
Brazil 12.50 20-07-11 Norway 2.25 12-05-11
Canada 1.00 08-09-10 New Zealand 2.50 09-03-11
China 6.56 08-07-11 Pakistan 13.50 01-08-11
Denmark 0.75 15-01-10 Philippine 4.00 09-07-09
ECB 1.50 07-07-11 Poland 4.50 08-06-11
Egypt 8.25 22-09-09 South Africa 5.50 10-09-10
Hong Kong 0.5 17-12-08 South Korea 3.00 10-03-11
Hungary 6.00 24-01-11 Sweden 1.00 26-10-10
India 8.00 26-07-11 Switzerland 0.25 12-03-09
Indonesia 6.75 04-02-11 Taiwan 1.63 30-12-10
Israel 3.25 01-01-11 Turkey 6.25 20-01-11
Japan 0.10 19-12-08 UK 0.50 05-03-09
Malaysia 2.75 08-07-10 US 0.25 16-12-08

The change in governance outlook of SBP is what the business and industrial sectors are banking on. The acting governor's remarks that he saw no immediate worry over the rise in inflation sound forward-looking and depict an optimistic mindset that endeavors to tackle economic issues through initiative and not by maintaining status quo. Government has achieved the zero-SBP-borrowing target in July this year but has substantially enhanced its borrowings from the banking system thereby further dampening private sector chances of getting a fair share of credit.

The private sector, on the other hand, is reported to have focused on debt retirement showing its scant respect to the idea of investing in the economy. This is a dangerous situation, which can only be handled if the state bank further reduces the key rate in quick successions.

The banking sector will also have to determine and put a cap on government borrowings to win back the private sector. Earning higher profits through accelerated investment in government securities can help in the short term only. The damage thus caused to the business and industry can shaken the very structure of the banking system in the end.