HIGH INTEREST RATES HURTING GROWTH

MOHAMMED ARIFEEN
(feedback@pgeconomist.com)

Oct 8 - 14, 20
12

The interest rate of a country is very important to the economy. The changing of the interest rate can have a great number of effects on how the economy performs, as well as on the people who benefit or are hurt by the economy.

Interest rates increases consumer spending, investment and the amount of loans people take out of the bank. Also, interest rates can increase foreign investment.

Generally speaking when interest rates are high, people do not want to take loans out from the bank because it is difficult to pay the loans back.

When interest rates are high foreign investment increases because foreigners want a larger return for their investment. This causes more demand for the dollar or pound in the international market.

High interest rate increases the cost of borrowing. Interest payments on loans are more expensive. This discourages people from borrowing and saving.

High interest increases incentive to save rather than spend. Higher interest rates make it easier to save in a deposit account because of the interest gained.

Rising interest rates affect both the consumers and business firms. Economy is likely to experience falls in consumption and investment.

Government debt interest payments increase. Higher interest rates increase the cost of government interest payments. This could lead to higher taxes in the future.

A rise in interest rates discourages investment. It makes business firms and consumers to a lesser extent willing to take out risky investments and purchases. In this context higher interest rates are inclined to reduce consumer spending and investment.

When interest rates are low, people are expected to take more loans out of the bank in order to pay for things like houses and cars.

When the interest rates are at low levels, it can have a widespread impact on the general economy, making it easier and less expensive for people to borrow money, but it can also have some possible negative side effects.

When interest rates are low, the average consumer has comfortable time borrowing money. However banks and other lending institutions make less money per loan because the interest rate is lower, so they tend to be more liberal with the amount of loans they issue.

Low interest rates can have a negative impact on the US dollar. When foreign investors are looking for places to invest their money, they look for countries where they can get a high rate of return. When interest rates are low, stocks become a more pleasing way to invest money.

From 1992 until 2012, Pakistan Interest Rate averaged 12.8 percent reaching an all time high of 20 percent in October of 1996 and a record low of 7.5 percent in November of 2002.

Pakistan's economy during the last few years has been hit by the low growth and high inflation. State Bank of Pakistan (SBP) feeling worried about unrestrained inflation cut the rate of interest by an astonishing 150 basis points to 10.5 per cent.

The interest rate reduction did have a trifling stimulus effect. In the current financial year, the net flow of credit to the private sector has been very low at Rs18 billion.

At present there is a need of adequate credit from the banking system and at a price that makes business and industrial operations feasible. The State Bank of Pakistan for a long time has been following a tight monetary policy to control inflation, it has been this time very cautious lowering the discount rate in anticipation of a further narrowing of the current account deficit and a loosening up of inflation.

The Commercial Banks in Pakistan charge high interest rates on their lending not simply because of the State Bank's monetary policy but because of their tremendous spreads.

The current spread is as wide as 7.5 per cent, a size not seen in regional competitive economies. Banking spread is 3 percent in USA, 1.7 percent in Japan, 4 percent in India, 4.4 percent in Sir Lanka and 5.5 percent in Nepal.

High banking spread in Pakistan is one of the major causes of low savings, dwindling investment and sluggish business growth in Pakistan.

State Bank of Pakistan must order commercial banks to narrow down the gap between lending and deposit rates for providing better returns to the depositors and encouraging savings.

After the winding up of PICIC, IDBP and NDFC, and the absence of full-bodied bond and equity markets, the task of responsibility of providing long-term credit for financing has been given to our commercial banks. These institutions unfortunately are still not well equipped to take such a strategic role of providing long - term credit facilities to private stake holders.

It is keenly observed that our banks usually favour lending to the sovereign and holding government securities instead of extending credit facilities to the private sector.

Pressure is always brought to bear on banks by the government to lend to the power sector and to all the major participants in the energy sector to help cut down the size of the circular debt problem.

In this state of affair it is the responsibility of the government to reduce the high banking spread and cut down the mark up rates to encourage savings, investment and easy credit facility for growth of business activities.

Banks are seen to be earning substantial mark-up income on the basis of high spreads and high interest rates, which is not a good sign and not considered a prudent approach to encourage the development of private sector in the country.

The high interest rate is increasing the cost of doing business in Pakistan and is also discouraging new investment. In such circumstances, the accelerated cost of production has made Pakistani products more noncompetitive both in national and international markets.

Pakistan is seeing a steep decline in private sector investment and it is the high time that State Bank of Pakistan should change its tight monetary policy and bring down discount rate to promote the private sector investment and growth of industrial and business activities.

At present the heavy borrowing approach of the Government from the banking sector is a cause of concern to the set back of the economy of the country. This is crowding out the private sector from credit facility and discouraging large investment from the foreign and private sector of Pakistan.

Instead of taking recourse to heavy borrowing from banks to reduce fiscal deficit, government should have taken measures to extend the tax base by bringing untaxed or informal sectors of economy or agriculture into the tax net, which is the correct way to bring forth extensive revenue and rid of the fiscal deficit.

Before the global economic and financial recession took place, there was significant amount of investment in Pakistan as it had a liberal investment policy. However, today the investment assumption has dramatically changed with Pakistan losing much its attraction to international as well as domestic investors, because of the rising costs of doing business.

The banks in Pakistan follow hard conditions and tiresome procedures while advancing loans to consumers. Mostly bank loans are granted to wealthy persons while the smaller businessmen are ousted by charging higher interest rates.

Pakistan is one of the few countries in the competitive regions where the interest rates are very high. The country is far behind its neighbours in economic development and exports due to high interest rates and energy crisis.

As compared to the 12.5 per cent interest rate in Pakistan, India's current interest rate is at 4.7 percent, Japan 0.1 percent and China 5.31 per cent.

Cost of doing business in Pakistan has been increased further by poor infrastructure. CNG and oil prices have recently risen to a higher level. Pakistan is producing about 20 percent of its oil requirement.

The banking spread in the country needs to be cut down. This will get rid of from the control of financial institutions like the IMF, World Bank and the Asian Development Bank (ADB). The interest rate should be brought down to a level of interest prevailing in the competitive regional countries.

The high interest rate is the major reason behind the decline in the country's industrial output. The downfall in auto, textile, electronic, petroleum, and other key sectors adversely affected the performance of large scale manufacturing (LSM) in the country.

Exporters are facing a lot of difficulties due to high cost of production. Cutting interest rates to a reasonable limit will produce multiple benefits for the economy, as it will lower the cost of doing business, give a strong boost to business and industrial activities, provide easy credit and loaning facilities to trade and industry, promote better investment and exports, and generate more tax revenue for the government.