Monetary policy

Days after the government announced it wasn’t able to meet its original growth target, the State Bank of Pakistan has reduced the interest rate to the historic low of 5.75 percent from 6 percent. The decision to cut the interest rate is an unexpected one – given that inflation is predicted to rise over the year. The government itself appears to be much more optimistic on this front with the claim that inflation will remain below the target. However, there is cause for scepticism. Consumer prices rose by 4.2 percent only in the month of April. The logic of cutting interest rates tends to be that it would encourage private-sector lending. A low benchmark interest is thought to be ‘pro-growth.’ The trouble is that the required impact is not likely to happen. Over the last year, the policy rate had been reduced significantly but private-sector lending has remained stagnant. The more likely reason for the interest rate cut is to reduce the government’s expenditure on debt servicing as Pakistan’s budget deficit continues to remain high.

Ironically, the government has claimed that growth remains robust despite a poor cotton harvest and falling exports. The banking sector, which has increasingly been lending to the government, had been lobbying for an increase in the policy rate. Domestic debt has now reached around Rs13 trillion. The SBP only recently rejected the offer of higher-interest bonds from banks. The politics around this seems to suggest that debt servicing costs have outweighed all other factors in making the decision. If our analysis is correct, then Pakistan’s growing debt burden is impacting key decision-making. And if inflation is to go higher while the policy rate remains low, savings are likely to be devalued which could lead to people pulling money out of banks. Too much cash floating in the economy is a good thing only if the economy is growing. This is not the case as confirmed by the growth projections of the government. Reducing the policy rate by 0.25 percent may itself seem to be trivial but underscores confused priorities.