RATE OF INTEREST AND INFLATION IN PAKISTAN
PROF. SAEED AHMAD SIDDIQUI
Nov 5 - 11, 2012
Inflation refers to a general rise in prices against a standard point of purchasing power. Previously, increase in money supply was called inflation which is termed now ''expansionary monetary policy' or 'monetary inflation'. Inflation in the present times is measured technically through comparing two sets of commodities with increase in cost at two points during a specific period of time. Although there are various methods to measure inflation but tow out of them are most correct and trustworthy; first CPI (consumer price index) which indicates the rise in the prices of goods and second GDP (gross domestic product ) Deflator which measures inflation in the economy as a whole. Inflation, currently comes into being due to intersection of money supply and output and rate of interest.
Tracing out the history of inflation in Pakistan, Highest rate of inflation, between 2003 - 2012, was recorded 25.3300 percent in August 2003 while it was at 10.4100 percent in July 2003. In other words, average rate of inflation during this period was recorded 10.6200. Rate of inflation in April, 2012 was 11.30 percent.
As far as trend of rate of interest in Pakistani, The history of rate of interest in Pakistan reveals that it was highest (20%) in October 1996 during the period 1992-2012 while it was lowest in November 2002; 7 percent. In other words, average rate of interest during the past 10 years was 12.8300 percent. Rate of interest in Pakistan was 12.5 percent in 2012.
Inflation and interest are interconnected. Borrowing is indispensable for every business or production activity. Loans are needed for constructing factory building, purchasing of machinery, equipments, raw materials, paying wages, meeting of overheads etc. All these expenses constitute cost of production. In other words, if the rate of interest is enhanced on borrowing, production cost is bound to increase. No business or production activity is adopted as fun but profit is the basic motive. If the cost of production increases due to enhancement in the rate of interest, increase in price of product is a must. In other words, rate of interest and price level move together in the same direction. Rate of interest and inflation, therefore, are indirectly related.
Current monetary policy of The State Bank of Pakistan was announced on June 8, 2012 in which it has clearly been mentioned that the Government of Pakistan has been borrowing recklessly due to which funds fell short with SBP to lend to the private sector. It is proved with the fact that the volume of government loans has reached to the extent of Rs. 1660 billion acquired from the banking system. Obviously, if this trend of public borrowing is not stopped or curtailed, it would not be possible to culminate the dream of arresting the inflationary rate at 10 percent into reality.
The banking system has been failed to extend needful loans to the private sector. Why? Banks are fully aware of the fact that borrowing has become indispensable for the government because the private sector, due to exemplary downfall in production activities is not capable now to provide revenue to the government according to its needs. On the other hand, the government expenditure is increasing persistently due to rise in salaries and allowances of ministers, extra ordinary expenses on foreign tours by the government officials and expansion in cabinets both federal and provincial. Energy crisis has added fuel to the fire. When the factories will have no electricity, what will they produce therefore borrowing would be the expensive business for them. When the banks can earn 12 percent profit without any efforts and risks, why will they lend to the private sector.
If rate of interest is reduced, it would affect people's willingness to save and if it is increased from 12 percent, enhanced cost of production would accelerate inflation further through fall in production. This is the reason that rate of interest has been kept unchanged (12%) in the latest monetary policy of SBP.
The question is that why economic reforms should be implemented in Pakistan? As the financial authorities are increasing short term internal loans rapidly, monetary policy of the SBP can't play effective role in these circumstances. Fall in the rate of inflation has totally been negated in the monetary policy declared on June 8, 2012. It is, therefore, necessary that basic economic reforms must be implemented for the positive change in the economy of Pakistan. Keeping inflationary rate around one digit will not only be difficult but impossible without curtailing public borrowing from the banking system and specially from the State Bank of Pakistan.
For curtailing the rate of inflation, other than financial reforms are needed. The ratio of private investment and GDP has gone down to the extent of 12.5 percent during fiscal year 2012 which emphasizes the need of financial reforms. Environment is not congenial for business and production because it has been smashed by energy crisis and worst law and order situation. Consequent to this, demand for credit in private sector has enormously been decreased. Prompt reforms, therefore, are required in energy sector for rebuilding the confidence of business sector.
Government of Pakistan is violating SBP (emended) Act of 2012 in borrowing excessively. In accordance with the monetary policy declared in June 2012, the pace of borrowing by the Government from the banking system has been extremely very fast. A net increase of Rs. 1098 billion took place in the public loans from the banking system between the periods July, 1 to May, 2012. Pace of borrowing from the SBP expedited from April 1 to June 4, 2012 adding Rs. 310 billion. Consequently, the total volume of loans payable touched the figures Rs. 1660 billion. Due to this open violation of SBP (emended) act of 2012, Not only the terminal loans are necessary to keep at zero but these loans will have to repay during the next 7 years.
In the light of prevalent level of inflation, economic future of Pakistan is very bleak. Mentioning aspect of tendency of dearness is its stay at a high point coupled with weak economic activity. Nevertheless, a hope has been expressed in the report of SBP that inflationary rate is not expected to rise fast during financial year 2012-13. It is expected that the rate of inflation would remain around the present level. According to the SBP, negative gap of income and expenditure of the financial authority is the main problem which can't be bridged up without financial reforms.
Repayment of loans, during 2013, is expected to increase so excessive influx of foreign money would be needed to keep the foreign exchange reserves intact.
The immediate and important effect of inflation is the curtail in purchasing power or the value of rupee. Inflation affects retired people hard with fixed income as their purchasing power decreases month to month. Those whose income is not fixed are comparatively in a better position because they can combat inflation by increasing their income. Another destabilizing effect of inflation is that the people, for cultivating advantage of increasing prices, increase their speculating activities. Since some purchases are called 'high risk investment', expenditure diverts from normal channel creating 'structural unemployment'. Inflation changes the pattern of income distribution. If inflation period is long, creditors face higher loss than the debtors. In other words, loan acquired in the past is repaid in deflated rupee. Inflation weakens the 'value storing' function of money because every unit of money, with the passage of time, becomes value less. During inflationary period, Progressive loss in value of money encourages the people to use it for the purpose of deferred payments.