October 30, 2002	Wednesday	Sha’aban 23,1423

KARACHI, Oct 29: The finance minister and the governor of State Bank seem to hold divergent views on the immediate need to reduce interest rates.

Finance Minister Shaukat Aziz said here recently that there was room for further reduction of commercial bank lending rates by two per cent.

In an interview to a foreign economic journal, State Bank Governor Dr Ishrat Husain observed: “We are not keen at this very moment to cut rates any further.”

The SBP governor supports his view on two counts: the assumption that interest rates are the prime factor behind a contraction in lending, is wrong. The prices have to be kept under a watchful eye to ensure that these price adjustments (oil products and electricity) do not translate into inflation.

Asked whether he saw any further relaxation in the interest rates, Dr Ishrat Husain said: “We have already cut rates by five per centage points, but if inflation remains low I might anticipate some further reductions.”

The SBP governor did not discuss how banking reforms would impact on intermediation costs and the spread between the deposit and lending rates of commercial banks and lead to reduction in interest rates in future.

The finance minister has however been pressing the commercial banks to reduce interest rates to single digit. The commercial banks appear to be opposing the move, although they are extending credit at 8-9 per cent to big borrowers with “best” risks.

In a recent report on monetary policy, ABN-AMRO Bank says: “In our view, however, monetary policy has delivered as much as it could.” In addition, the report says, “SBP appears to be mindful of the rising inflationary pressures in the economy — and is correctly staying its hand as a consequence.... The monetary policy will be needed to be complemented — rather than countered — by the fiscal stance to re-spark growth.”

On the other hand, it is strong rupee that reduces cost of industrial materials and it is reduced interest rates that cut financial charges and make industrial production and exports competitive, says a leading textile exporter. It is not the demand for credit but the financial charges that is at the heart of the matter, he added.

Lower interest rates and stable rupee mean reduced servicing costs on both foreign and local debts for corporates, creating savings for investment and more fiscal space for development spending.

The State Bank report 2001-02 says that the government should stick to its promise to enhance development spending. Finance Minister Shaukat Aziz has been making public statements saying the dollar was overvalued and its real worth was around Rs55. He is perhaps looking at cutting debt servicing costs to save money for development.

Interest rates are a sensitive issue for governments. It may be recalled that varying perceptions on the issue between a former governor of State Bank, Dr. Muhammad Yaqub and the Nawaz government soured their mutual relationship. The PML (N) persuaded the commercial banks to bring down the interest rates by two per cent.

The budget and balance of payments deficits worsened in the 1990s, and impacted adversely on the economic growth rate because of the IMF and World Bank policies.

It is on the persuasion of the IMF that the State Bank increased rapidly return of T-bills from 6-7 per cent to 16-17 per cent, that made budget deficits unmanageable. It sent commercial bank lending rates soaring to 20-22 per cent that turned profitable industrial enterprises into sick units.

Similarly, the World Bank encouraged setting up independent power plants based on furnace oil that inflated import bills on petroleum products and worsened the balance of payments. It led to devaluation of the rupee, and along with exorbitant interest rates, made investment prohibitive.

To top it all, US and Europe imposed multi-layer sanctions that dried up capital inflows and forced the Nawaz government to resort to borrowing at short-term commercial rates.

And the present policymakers have laid the entire blame on political governments.

Whether the government can find fiscal space for more development spending and corporate a congenial environment for investment, would depend on a stable exchange rate and a declining interest rates.