Discount rate stability

There will be many who will breathe a sigh of relief over the decision of the State Bank of Pakistan to keep the discount rate unchanged at 13.25 percent. With the pattern in the last twelve months being upwards, the SBP seems to have temporarily decided to put a stop on such hikes. According to some reports, the Ministry of Finance is at loggerheads with the SBP over the recent hikes in interest rate. The trouble however is that the high discount rate is translating into a massive increase in the country’s budget deficit. It is estimated that each percentage point increase in the policy rate translates into a Rs130 billion increase in interest payments per year. Some officials in the finance ministry believe that the real interest rate stands at 8 percent in the country, which leaves little justification for keeping the policy rate at 13.25 percent.

The SBP has made its view on the matter clear earlier. It claims that it must match the high inflation rates as well as increase the policy rate to discourage government borrowing. The trouble with the second reason is that government borrowing does not work this way. If anything, any increase in policy rate is likely to increase government borrowing, under the assumption that tax collection will remain the same.

While it is true that the government is pursuing an aggressive taxation policy, the budget numbers continue to show a record budget deficit – in which the SBP policy rate has no small part to play. Economists have also raised concerns over the impact of such a high policy rate on private-sector borrowing. This means that keeping the policy rate high would severely impede any plan to revive the economy. The government has taken a strange stance on the mushrooming of government debt. While the debt owed by the central government has ballooned by Rs1.23 trillion during July, Adviser to the PM on Finance Dr Hafeez Shaikh has claimed that the net addition is just Rs26 billion due to the reduction in the exchange rate from Rs163 to almost Rs160 to the dollar. This is strange logic, especially given the fact that much of the state borrowing is through treasury bills. The truth is that there are no easy decisions to be made. But there are certainly some wrong ones that could be made. The policy rate decision is one that needs to be revised quickly to bring it into line with ensuring a quick economic recovery.