With SBP policy rate at 13.25%, & borrowing costs for many businesses well above 15%, there’s recently been an increasingly loud drumbeat demanding that the SBP lower interest rates. This has culminated in a former IMF official filing a petition with the Supreme Court (1/n)
to order the authorities concerned to cut interest rate to save Rs1 trillion annually & place capital controls to ensure orderly withdrawal of so call portfolio investments in TBs. Dr Zubair Khan’s petition pleads, “The court may kindly order the federal government (2/n)
to lower the policy interest rate to 6-7%, which will reduce the allocation of public funds for interest payments by about Rs1 trillion”.
The petitioner is a regular guest on television shows where anchors give him free rein to express his views on economic policies without (3/n)
The petitioner is a regular guest on television shows where anchors give him free rein to express his views on economic policies without (3/n)
ever drilling down the derivative consequences of his proposals. Given his petition with the Supreme Court of Pakistan, it might be useful to examine his proposal closely. To begin with, it's important to accept that commercial banks, like all other rational investors, (4/n)
look at real returns rather than simply focusing on nominal rates. With SBP forward expectations of inflation at around 12.5-13%, & policy rate at 13.25%, real interest rate is positive but less than 1%.
If policy rates were reduced to 6% as proposed in the SCP petition, (5/n)
If policy rates were reduced to 6% as proposed in the SCP petition, (5/n)
the central bank would be providing a negative 6% rate of return. As banks margins get squeezed due to such a negative return, bank profitability wud also be severely dented. Far from spurring on additional lending, banks wud be forced to rein-in credit and refuse deposits (6/n)
in order to shrink their balance sheets to preserve capital. As banks withdraw from the lending business economic growth will suffer. Ironically many corporations that are currently demanding the lowering of interest rates are also likely to hold back investments (7/n)
given the uncertainty of the monetary policy. Moreover, negative real rates are likely to further exacerbate inflationary pressures. Loose monetary policy pushes up consumption and thereby consumer prices. Also, it's likely to push up values of financial assets (8/n)
&high-end luxury goods as well as create property bubbles. Asset bubbles and consumption-led demand may help certain businesses, but would result in persistence of inflation, destruction of the savings, and tepid long-term growth. (9/n)
Moreover, increased domestic consumption will result in CAD, which the government has worked hard to curb, to once again burgeon to unsustainable levels. This will put pressure on exchange rate. With rupee depreciating, reserves falling, & capital controls in place, (10/n)
Pakistan is not only likely to see all foreign investment into the country stop, but potentially overseas Pakistanis inward remittances also decline. Should the country go down that route it would soon find itself self-inflicting an economic crisis. (11/n)
Just when the country needs to integrate further the economy with rest of the world and participate in global value chains, artificially low interest rates and capital controls will force the nation towards being an autarky with all that entails. (12/n)
Few things could be more dangerous than having negative interest rates in a high inflation environment that presently exists in Pakistan. It is also worth asking the petitioner the rationale for choosing 6% as the base rate. (13/n)
Given that the petitioner wishes SBP to abandon its effort at curbing inflation why not suggest a zero-interest rate policy (ZIRP). (14/n)
The petition states in one place that interest rate have little to no effect on private sector borrowing, but in another part submits that businesses, especially large scale manufacturing, are contracting due to the rate hike. There appears to be a lack of consistency. (15/n)
While not wishing to sound alarmist, should the Supreme Court take up the case, international investors may want to withdraw their investment given the potential of imposition of capital controls as proposed in the petition. (16/n)
If foreign portfolio money were to suddenly exist, the Pak Rupee is likely to see further depreciation. This is likely to be followed by inflation going up further. Perversely the net effect is likely to push up interest rates - exactly the opposite of what petition seeks (17/n)
Finally, it is worth reflecting on what would be the long-term consequences on the independence of SBP should the judiciary choose to intervene in setting the monetary policy of the country
