(MENAFN- Khaleej Times) Pakistan has announced a dramatic discount rate cut - down to seven per cent - to boost business on a fast track, reversing its 42-year history.
State Bank of Pakistan (SBP), the central bank cut the Discount Rate (DR) down 100 basis points from eight per cent to the seven per cent, the lowest since August 1973. The new rate, effective from May 25, will bring down the cost of borrowing and the cost of doing business in the country. The surprise move will help spur production, create more jobs, raise stagnant exports and further improve the external balances in months to come.
A look back over the discount rate and Monetary Policy record shows the interest rate decline from 13.5 per cent in September 2010, down to 10 per cent in May 2014 when the pro-business Prime Minister Nawaz Sharif took over the government, and by now, still falling down to seven per cent in May 2015. Partly, it happened due to Sharif being pro-business and against corruption in the top bureaucracy. But the key cause was the external factors including the big slash of the international oil and commodity prices, which helped restrict the overall import bill. It also helped in reducing the cost of production of the exportable goods, specially those sent to UAE in the Middle East, EU, and US.
In sharp contrast, during former president Pervez Musharraf's rule from 1999 to 2005, the commercial banks interest rates had gone up to an astounding 18 per cent. It has been a huge task to scale them down.
A constant decline in inflation and cheaper commodity imports, particularly those of oil, and the growing improvement in external finances helped trigger the discount rate cut, which will filter down to the business in the form of lower interest charges by the commercial banks. However, it will also mean a further squeezing the commercial banks' spread - the difference between what they charge the borrowers and what they pay to their savers. In the bankers' heydays they were enjoying up to 7.5 per cent spread - the highest in the word, which is now coming down. In order to protect savings, which are slow to generate, and to prevent their slide down further, the minimum savings or profit rates have been set at five per cent - down 0.5 per cent from the prevailing 5.5 per cent.
"Given the macroeconomic conditions, the board of director of the SBP has reduced the policy rate by 100 basis points to seven per cent which is the lowest in the last four years," SBP governor Ashraf Mahmood Wathra said in the official announcement.
"The current microeconomic stability, achieved through domestic policies and favourable external developments provide an opportunity to focus on economic reforms that will put the economy on a sustainable growth path," Wathra said.
The reduction in the interest rate will "promote the business activities in the country and reduce the input cost. The current low inflationary trend allowed the central bank to cut the interest rate in successively policy announcements since November 2014 onwards.
Downward inflationary trends have helped a lot in keeping the slow and stagnant economy on its tracks. SBP projects the Consumer Price Index (CPI) inflation in the range of four per cent to five per cent for the whole financial year of 2014-15, down from the original projection of eight per cent.
The low inflation syndrome, and the similar projection for the foreseeable future, has encouraged the SBP to what some economists say "test the boundaries of interest rates, possibly ushering in a new era of lower borrowing costs for the entire economy."
The SBP board has also reviewed the interest rate corridor - the maximum and minimum inter-bank rates. It reduced the upper ceiling by one per cent to seven per cent and fixed the lower cap at five per cent, bringing it down by one per cent from 5.5 per cent. Wathra said the BoD reduced the width of the corridor to two per cent, from 2.5 per cent to ensure predictability in the money market. Now the upper ceiling is seven per cent while the floor is five per cent.
"Although the key interest rate is seven per cent, the SBP will target the 6.5 per cent rate and will ensure that the Repo Rate (the repurchase rate) remains close to the target rate," Wathra said.
The SBP governor also says that in the wake of the previous reductions in the discount rate, there has been a significant growth in long-term loans and trade financing quantum jump. "SBP is of the view increased availability of electricity and natural gas to the industry, which has, so for, adversely affected their production level, as well as better law and order situation will provide further impetus to reviving investment and higher production."
The SBP said gradual realisation of the planned investment in energy and infrastructure projects will provide additional boost to growth. Consequently, growth is expected to be revived at a relatively faster pace going forward.
The central bank further noted that Pakistan's current account deficit has narrowed down, the average annual inflation is significantly below the projection, there is a marginal up-tick in the real GDP growth to 4.2 per cent, and foreign exchange reserve build up continues. All these developments were reflected in the recent upgrades in outlook by the international rating agencies that have further improved the investor confidence.
The central bank's report gives a big applause to the help of the Overseas Pakistanis, working in the UAE, Saudi Arabia, UK and US, for sending ever-rising home remittances.
"With contraction in imports, led by a sharp decline in oil prices, and strong growth in remittances, the external current account deficit, at $ 1.4 billion during July-April 2015, is around half of the deficit recorded in the corresponding period of financial year 2014."
The forex reserves are expected to increase further due to the subdued outlook of international oil prices, successful continuation of the Pakistan's IMF programme, and realisation of the expected official foreign inflows. Increase in foreign private investment inflows (FDI) can further strengthen the outlook and sustain stability in the forex market. SBP's own forex reserves rose from $9.1 billion as of June 30,2014 to $12.5 billion as of May 15, 2015. The commercial banks own more than $5 billion, retained with the SBP.
The business and industry has unanimously welcomed the new interest rate cut. Mian Mohammad Idrees, president, Federation of Pakistan Chambers of Commerce and Industry (FPCCI) said, the lower cost of credit will revive confidence of the private sector in the government. Consistency in economic policies is a key to achieve robust growth. The FPCCI has been proposing to the government that without a seven per cent GDP growth rate, issues of poverty and unemployment cannot be tackled. Similarly, law and order situation cannot be improved without providing jobs to the youth.
Ijaz Mumtaz, president Lahore Chamber of Commerce and Industry, said the SBP governor deserves appreciation for bringing down the interest rate to seven per cent.
"A considerable cut in the discount rate is a panacea to investment phenomenon. The cut will help ensure availability of cheaper money to the cash starved private sector, besides encouraging the potential foreign investors to invest in Pakistan."
S. M. Muneer, chairman of All Pakistan Textile Mills Assoiciation, the country's biggest industry, largest labour employer, and the highest exporters, welcomed the reduction in policy rate by 100 basis points.
"It will provide relief to the industry, especially the liquidity-starved textile industry which is already facing high cost of doing business in this region. The textile exports were registering a downward trend due to the currency crisis in EU," he said.
Dr Salman Shah, former finance minister, gave a different opinion and said: "Though the rate cut is encouraging, it is unlikely to have a positive impact on the economic revival and growth, given the deflationary environment."
He said the record low slash in the interest rate is just a popular notion by the government to gain political support and sympathy. The easing stance is just a single stimulus to boost the real economic activity in the country,"
Dr Ishrat Hussain, former governor of SBP said: "I am optimistic about expansion in the private sector credit. The decline in the cost of borrowing will spur private sector lending and motivate households to increase spending. At the same time, the government's interest payments on domestic debt will slide by two per cent with the downward revision in the interest rate."
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