Monetary Policy (The News)

Monetary policy contentious as ever

Floods, collapse of law & order and acute energy shortage are enough to wash away all the government’s macro-economic targets. The businessmen want to add high interest rates to this list, a contention that is brushed aside by most economists. The policy to control inflation through tightening of monetary expansion has always remained contentious between the pro-growth businessmen and the economists.

The debate is old. Way back in 1960s Prof. C. Walter Woodworth in his book The Money market and Monetary Management had said: “While economic growth is unquestionably a primary goal of the economy, there is a heated controversy in regards to its qualifications as an object of monetary policies. During the postwar years Board of Governors (US Board) has officially accepted it as one of the principal policy guides.”

When the State Bank of Pakistan announced earlier this month to raise the discount rate by 50 basis points trade bodies as usual condemned it and dubbed it “an anti-investment policy.” Interestingly, lobbied by the business community, our Chairperson of National Assembly Finance Committee Fauzia Wahab also joined the cribbers and dubbed it as an anti-people move. The problem with the chairperson is that she is often found on the wrong side because the business lobbyists have her ear and economists are kept at arm’s length. On her own she is politician and is not well-verse with complicated economic matters.

When I talked to her party’s economist Qaiser Bengali, who has also worked on the issue of interest rates and growth at SPDC, said that the SBP decision to raise the interest rate to control the surging inflation was a right decision to check rising prices. He thinks that low interest rates are misused by the speculators for hoarding the commodities.

Qaiser Bengali does not agree that there is much impact of the interest rates on investment as claimed by the business community. When he researched on the subject, he found that investment is more stimulated by the tax reliefs instead of low interest rates.

Former State Bank Governor Dr. Ishrat Husain, who had pulled down interest rate from around 21% to 12% during the initial years of Musharraf era, also backed the recent SBP move to inch up the interest rates. Like true professional he said that he could bring down the interest rate because inflation rate was hovering around 4-5% and Pakistan debt to GDP ratio was high. “Now that the inflation rate is running in double digits the SBP had no option but to follow tight monetary policy,” he explained. To back up his argument, he said that even in India which has GDP growth rate close to 9% the Reserve Bank has pushed up the interest rates.

Dr. Husain dismissed the fears of industrialists who are criticizing the SBP decision and maintains that the impact of interest rate on cost of production is 10% hence nominal increase in the rates does not hurt the business. “On the contrary it dissuades the speculators, who borrow push up commodities prices,” he argued.  He also disagreed with business community that the SBP decision would affect the business and would further fuel unemployment. “Only one million works for the organized sector that borrows from the bank, the rest are employed by agriculture and service sector where interest rates do not matter much,” Dr. Ishrat pointed out.

But the business community feels that every little bit counts in these bad times. While the big boys may swim out of the economic deluge, the small and medium entrepreneurs who are already facing serious economic crunch may sink. One sign of SMEs drowning is that most of them have started defaulting on their loans to the banks. In turn the medium and small banks which had gone all out for the SMEs in better economic times — in the first half of this decade — are now in serious trouble. While some of them are in the process to merge to save themselves, others are offering voluntary separation schemes to their employees. So it is the whole business cycle which is under strain already.

Those who give example of the Western economies growth stimulating packages that include cutting the interest rates drastically and infusing public money in big projects, should take a pause and consider this. The developed economies have very low inflation rate, have huge reserves and are not faced by calamities and complete breakdown of law and order. And countries like US fear deflation. They are also getting huge amounts of direct and portfolio investments.

The government’s effort to stimulate growth by allocating huge amounts for the federal and provincial development programme may now have to be diverted to the massive reconstruction of the flood affected infrastructure. At the same time as business has been affected by floods and target killings in Karachi the revenue target would also fall much short of the projection. This would further push up the government borrowings at a high cost and consequently the government is going to breach the fiscal deficit mark.

Businessmen should have a heart as the government which is the biggest borrowers is going to suffer higher interest rates more than anybody else. (

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