Jan 24 - 30, 20

Heavy government's borrowing from the central bank as well as from commercial banks exerts multifaceted effects on the economy. On one hand, it provides a safe haven to the commercial banks for the safe and secured investment in the government papers with high returns while on the other hand the credit to private sector becomes a low priority to banks obviously due to growing risk of infected portfolios and non-performing loans.

Yet another impact of the excessive borrowing by the government appears in the form of unruly inflation, which consequently provides an option for the State Bank of Pakistan to raise the interest rate.

In this backdrop of rising inflation, there was a general concern especially amongst the trade and industry circles for yet another hike of 50 bps in the discount rate which consequently ups the interest rate to 14.50 per cent, as the central bank was scheduled to review its monetary policy on January 29.

The high interest rate has adversely affected the growth rate of the large manufacturing sector and is being viewed as a major concern by the trade and industry circles in general.

According to latest data, the Large Scale Manufacturing (LSM) production during July-November 201010 has posted a 2.3 per cent decline year on year basis while the LSM index has nose dived since July 2010 primarily due to slow economic activity on the back of rising inflation as well as the high interest rates.

Commenting on the high cost of financing, Pervez Ghias, Chief Executive Indus Motors said that the automobile industry has experienced a steep fall in sales number mainly due to high cost of financing.

It will be interesting to note that contrary to the depressing economic activity particularly in the automobile sector, the auto makers have come out of the worldwide financial crisis and easy financing is the major factor behind regaining the automobile boom elsewhere in the world.

The financial analysts are of the firm opinions that with the rise in interest rate, the LSM production would take a noticeable dip during 2011 as the key LSM players such as textile, food, petroleum products, chemicals, auto and metallic and non-metallic were on the road to decline in production, unless the policy makers take measures imperative for improvement in the inter-corporate debt and energy deficit and stability in inflationary swings.

It will not be out of place to mention that the existing interest rate at 14 per cent is one of the highest in the world, compared to India at 6.25 per cent, China at 5.56 per cent, Thailand at 1.5 per cent and South Korea at 2.25 per cent.

The banking spread in Pakistan is 7.6 per cent, which is the highest in the world and this makes it impossible for industry to survive and compete in the international market.

The trade and industry fearing another hike in interest rate at the end of this month has expressed serious reservations over the expected increase.

Khalid Tawab, Vice President Federation of Pakistan Chambers of Commerce and Industry (FPCCI) came out with some sharp remarks that SBP continued to operate a tight monetary policy despite the clear evidence that such policy asphyxiated investment and trade activities and has hampered the growth of manufacturing in Pakistan.

The increase in interest rate is used for containing inflationary pressures in the economies where fiscal discipline is given high priority, while in our case the printing of currency and borrowing by the government mar the effectiveness of the tight monetary policy to check the rising inflationary trends.

Although manufacturing sector growth has begun to recover this year, it is still lower than financial years 2007 and 2008 levels, due to lower bank credit to the private sector, which was estimated at Rs112.90 billion, as compared to Rs369.85 billion in financial year 2008. Pakistani banks would face the spectre of rising non-performing loans (NPLs) in the new calendar year, as higher lending rates and a weak economy continues to deal a double blow to borrowers' repayment capacity.

It may be recalled that Pakistan experienced catastrophic floods last year, which had serious implications for macroeconomic stability and growth prospects. It is expected that the floods will reduce economic growth rate by 2 to 3 per cent. In this scenario, when private sector investment is needed in the country, SBP is using a tight monetary policy to compensate for the government's borrowing for financing its current expenditures, Khalid remarked.

Moreover, our non-performing loans are 9.1 per cent of total gross loans, which is higher compared to other Asian countries, i.e., India 2.3 per cent, China 2.4 per cent, Malaysia 4.8 per cent and Thailand 5.7 per cent, which should be minimized for attaining sustainable growth.

Discussing the prevailing economic depression in the wake of high inflation and rising cost of financing, Khalid said that SBP justifies the higher interest rate in Pakistan because of the higher inflation in Pakistan.

In Pakistan, the nature of inflation is not demand- pull, which can be controlled through a tight monetary policy. It is a supply side phenomenon, whereby the major cause of rising prices is an increase in the prices of industrial inputs and shortage of essential items of daily necessity. All of these are price inelastic products and monetary policy can not control their prices.

Khalid Tawab suggested to the policy makers to focus on increasing the demand for credit by reducing the discount rate to a single digit figure to spark the economic activity as generating economic activity means generating more revenue for the government.

The people at the helm of affairs can understand that simple formula of generating revenues is to activate the economy right from the grass root level of the cottage industry. Actually, the monetary policy is contradicted by our fiscal and trade policies, which are based on the expansion of private sector credit facilities under different incentives and schemes.