The economic maxim “the higher the interest rate, the lower the inflation” has not been proven in Pakistan. Instead of relying on cold statistical economic indicators, the State Bank of Pakistan should consider the ground realities and reduce the policy rate to a competitive level.
The State Bank of Pakistan (SBP), while announcing the Monetary Policy Statement on January 29, 2024, decided to maintain the policy rate at 22 percent. The statement contained several justifications and objectives achieved by maintaining the policy rate. The SBP, while emphasizing the continued fiscal consolidation and timely realization of planned external inflows, envisaged achieving the inflation target of 5-7 percent by September 2025.
The Monetary and Fiscal Policies Coordination Board under Section 9G of the SBP Act, 1956, among other things, requires the governor SBP and the Minister of Finance to establish a close liaison through a mutual agreement with each other and shall keep each other fully informed on all matters which jointly concern the Bank and the Ministry of finance. Whereas the Ministry of Finance, under the Rules of Business, 1973, is, among other things, responsible for (a) all matters affecting the country as a whole, (b) advice on economic and financial policies, and (c) investment policies. The concerned ministries and divisions, viz. Planning Commission, Ministry of Commerce and Industries, in terms of their functions defined under the Rules of Business, 1973, should, from time to time, bring to the notice of the Board through the Ministry of Finance the impact of monetary policy adopted by the State Bank on investment, growth, the balance of payment, imports, and exports. This is required to ensure consistency among macro-economics, growth targets, inflation, and fiscal, monetary, and external accounts.
What analytical inputs the ministries give to the Board is a big question. One also wonders what mechanism these organizations have, apart from the data produced by the Federal Bureau of Statistics (FBS), to measure the effects of maintaining such a high policy rate on individuals and the overall economy both in micro and macro terms. For individuals, such irrationally high policy rates increase the cost of borrowing, improve returns for savers, increase mortgage interest payments, increase the cost of bank loans and the willingness of the banks to lend more, and reduce borrowers’ confidence. Whereas its effects on the economy should, among other things, result in the appreciation of the currency, making exports less competitive and imports cheaper, it should primarily reduce inflation, slow growth, and increase unemployment and borrowing costs.
Pakistan is a producer’s economy, and when it produces, it imports and locally purchases raw materials and supplies goods domestically and internationally. The activity generates much-needed economic activity, revenues, and employment opportunities, which is the need of the hour. The high policy rate has stagnated all these activities and has not enabled the government to control inflation.
The economic measure to increase the policy rate to control inflation currently does not apply to the particular features through which Pakistan’s economy is passing through, with dirty and untaxed wealth freely circulating, making SBP policies ineffective, counterproductive, and detrimental for the downtrodden segments of the society making their lives miserable with each passing day.
The segment of society that has free, unearned, dirty, and untaxed money can purchase anything at any price. For them, goods and services produced and supplied at higher cost with twenty-two-plus financial costs make no difference. On the contrary, the lower and fixed income groups, whose salaries and wages are not in line and proportion to the prevailing cost push plus artificial hyperinflation in the country, are making life miserable for them; in most cases, this segment is barely getting one meal a day, let alone other basic amenities of life.
Even the government borrowings are causing unimaginable high inflation, now attaining a snowball effect. Some government-controlled organizations dealing with commodities and essential food items meet their financial requirements through credit limits from commercial banks at 22-plus bank interest rates. A public sector organization is meeting its annual administrative overheads of about Rs.12B by acquiring funds from commercial banks at 23.5% markup. Likewise, another organization engaged in purchasing and storing essential commodities to the tune of about Rs.170B annually acquires credit from commercial banks at 22% plus markup.
All this is ultimately charged to the consumers below the poverty line. In some instances, some ministries are providing subsidies through bank borrowings and are paying twenty-two plus bank interest rates on the number of subsidies given by them and the outstanding receivables of some organizations, thus unnecessarily increasing the end price for the consumers apart from unwarranted burden for the national exchequer. This is indeed equivalent to irrational financial management and poor governance.
This is required to ensure consistency among macro-economics, growth targets, inflation, and fiscal, monetary, and external accounts.
Today, Pakistan is passing through economic turmoil with a dwindling economy. It appears that the theoretical economists are not considering the ground realities and, to stabilize the economy, have caused further deterioration and torn the fabric of the society, turning inflation into hyperinflation, which is now getting out of control. Many voices have been raised in the print and electronic media against inflation, the slowdown of the economy, and the depreciation of the rupee caused by irrational fiscal and monetary policies. Still, the concerned authorities are paying no heed. The situation demands that the concerned ministries realistically take account of investment, growth, and balance of payment and bring it to the notice of the SBP.
The interest rates in the countries that are trading partners of Pakistan are much lower than the prevailing interest rates being maintained by the SBP. Article 18 of the Constitution of the Islamic Republic of Pakistan requires the regulation of trade, commerce, or industry in the interest of the free competition therein. Since the interest rates have a direct bearing on economic growth, trade and industry, cost of production, and the levels of protection against imported equivalents, fixation of interest rates higher than the prevailing interest rate of Pakistan’s trading partners is tantamount to a violation of Article 18 of the Constitution of Islamic Republic Pakistan.
While coordinating fiscal, monetary, and exchange rate policies, the SBP has to ensure consistency among macroeconomics, growth targets, inflation, and fiscal, economic, and external accounts. The current SBP Act makes the bank totally unaccountable to any supra body. However, no provision under the constitution and the SBP Act of 1956 provides immunity from being questioned by the apex court of law for protecting the interests of the citizens of this country.
The SBP’s function to fix the policy rate should be tied and correlated with ground realities apart from the economic principles and considerations. Moreover, it should consider prescribing separate policy rates for investment in industry and consumer banking. This will not only enable the government to ensure economic growth in the country swiftly but also enable it to control inflation in the intended consumer sectors. The Bank should consider the ground realities instead of the cold statistical economic indicators and reduce the policy rate to a competitive level.
The impact of monetary policy adopted by the State Bank on investment, growth, balance of payment, and imports and exports reported by the Planning Commission, Ministry of Finance, and Ministry of Commerce should be made public as part of the Monetary Policy Statement. An oversight system must also be devised under the parliament to monitor the Monetary Policy Committee (MPC) of the SBP and its analyses. The economic maxim “higher the interest rate, lower the inflation” has not been proven in Pakistan.
