The country’s leading economic experts, industrialists and businessmen rejected the increase in policy rate by the Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) – in an off-cycle review where they raised the benchmark interest rate by 300 basic points (bps) to 20 percent as country is making an all-out effort to unlock the immensely important $1.1 billion fund from the International Monetary Fund (IMF).
It is pertinent to mention that MPC has decided to increase the policy rate to its highest level in 27 years (since October 1996) in an effort to anchor inflation expectations as it is senstitive and warrants a strong policy response.
SBP has in total increased interest rate by 1050 bps since January 2022 in a bid to counter increasing inflation.
‘300 Bps increase will badly hurt businessss and trade’
Speaking to The Friday Times (TFT), Co-Founder Chainstore Association of Pakistan and Managing Director of Hub Leather (Urban Brands) Asfandyar Farrukh says that the policy rate hike to 20% will badly hurt businesses and trade in the formal sector while increasing the shift to the burgeoning informal sector where lending is generally cheaper.
For him, the increase will have no significant impact on the parallel economy which is estimated to be 50-60% of the overall GDP while the banks will profit further at the expense of banked businesses, consumers and the taxpayers who fund the government’s debts.
Farrukh believes that the inflation that we are seeing is because of supply-side factors such as induced shortage of goods, spike in fuel and utility rates and rapid currency devaluation.
“As a result, monetary tighting is likely to have have a very limited effect on controlling inflation and will primarily only serve to satisfy the IMF,” he concludes.
Leading industrialist Waleed Saigol is of the opinion that MPC don’t had much of a choice given the unprecedented inflation levels in the country and the strict demands of the IMF.
“I do wonder where we are going with this though, inflation in Sri Lanka is 51 percent and the discount rate is 15.5%,” he points out.
‘With massive deprecation of rupee, inflation will continue to rise’
For Saigol, with the massive depreciation of the rupee continuing, inflation will continue to rise and we will be forced to keep increasing the rate, we are getting stuck in a loop.
“We must find ways to bring inflation under control, I think opening the Indian border to bring in cheaper commodities is something we need to seriously consider immediately,” he suggests.
Senior economist Dr Aima Mehdi, who is currently based in the UK tells TFT, increase in interest rates is one tool that central banks can use to control inflation.
How do interest rates work as a tool?
However, Dr Mehdi says it is essential to understand how interest rates work as a tool.
She maintains the usual economic phenomenon is that when interest rates rise, people have greater incentives to save which leads to reduction in spending hence demand falls and prices are forced to come down.
“This also leads to rise in demand for domestic currency as a profit/interest bearing tool,” she points out.
The scenario is not that simple in Pakistan
However talking about Pakistan, she says, the scenario is not that simple. Source of inflation needs to be understood to the core.
For Dr Mehdi, currently, major issue is rise in food, energy and petroleum prices which needs to be dealt with structurally. There is a bulk of academic literature which shows that monetary policy as a tool becomes insignificant when it comes to structural issues.
She maintains as a food importer, corroding value of the rupee is showing its effects as food price continue to rise. On the other hand IMF’s tough conditions have lead to rise in fuel and power costs. These issues need structrual solutions.
“Merely increasing interest rates with the intention that demand will reduce will in turn result in slower economic growth, reduction in production, rise in unemployment and hence more chaos,” she concludes.
‘Increase in policy rate will dampen already retarded business growth’
Agreeing with Dr Mehdi, leading tax consultant and an economic expert, Dr Ikramul Haq says that the decision to increase policy rate to 20% on the demand of IMF to counter at least headline inflation will dampen already retarded business growth and increase further burden of the government in respect of future borrowings and servicing the existing debts.
“The foreign debts have already been increased substantially due to massive devaluation of rupee.
It will also not bring down the rising inflation that has assumed alarming proportions—highest in the last 50 years,” he notes.
For Dr Haq, it may, however, help to get the much-needed tranche and support of IMF to tackle huge balance of payment challenges—almost US$ 35 billion are needed every year till 2030 by Pakistan to retire foreign debts and fund trade deficit.
The leading tax consultant maintains that it needs to be highlighted that the reasons for CPI inflation at 37.1% and unprecedented food inflation of over 40% are due to supply shortages because of import ban, rising cost of inputs, hoarding and smuggling, increase in prices of utilities and POL products as well as higher indirect taxes coupled with monstrous money supply.
Dr Haq believes the present sorry state of affairs is due to perpetual bad governance, unfunded subsidies for the rich and mighty, huge unproductive wasteful expenditure on running big and inefficient governments and state owned corporations and use of oppressive taxes to narrow ever-increasing fiscal deficit and losses in energy sectors etc.
‘Rise in policy rate cannot control hyperinflation for food items’
The economic expert further maintains that the cost push inflation, turning into hyperinflation for food items, cannot be controlled by rise in policy rate.
“We need fundamental structural reforms to overcome the existing mega economic crisis,” he says.
However, acclaimed economist Dr Sakib Sherani while speaking to TFT says, “The higher than market consensus increase in the policy rate is indicative of two things: first, the elevated inflationary pressure in the economy, and second, that the SBP is finally jettisoning its reactive policy stance and is catching up with the inflation curve.”
Economic expert Dr Muhammad Zubair Khan terms the increase in policy rate as sucidial. “All of them are illiterate and wants to close down the country on IMF’s instructions,” he concludes.
Steel Raw Material Shortages and Overhead Costs Drive Industry to Brink of Collapse
Speaking to TFT, Wajid Bukhari, Secretary General of the Pakistan Association of Large Steel Producers (PALSP) says that the steel industry is in the midst of an unprecedented crisis, with many large producers struggling to stay afloat as costs continue to mount.
“At the heart of the issue is the recent decision by the State Bank of Pakistan (SBP) to raise interest rates to record levels as mills are paying over 20% Kibor. This move is putting unbearable strain on businesses that are already operating at just 30% of capacity,” he maintains.