KARACHI, April 11: The State Bank on Monday increased its discount rate by one-and-a-half percentage points to nine per cent after more than two years to fight inflation. The SBP had last changed its discount rate in November 2002.The discount or repo rate is the rate at which banks can borrow funds from the central bank for up to three working days against government securities.
During nine months of this fiscal year, inflation increased by 9.06 per cent. The State Bank has already revised full fiscal year inflation to 8.2-8.88 percent against the initial budgetary target of five per cent.
The increase in SBP discount rate signals that the central bank is getting serious in fighting inflation, but economists and bankers say this would have to play a negligible or no role at all in containing inflation. They, however, say that a huge one-and-a-half percentage point increase in the discount rate will have a psychological impact on those involved in speculative activities because they would take it as the strongest possible clue for further increase in interest rates. (A more than four per cent fall in the KSE 100-sahre index came as a proof. KSE-100 index shed 349 points or 4.6 per cent to close at 7244 on Monday. Analysts attributed the fall to the increase in discount rate).
Commenting on the increase, Dr Asad Sayeed, a noted independent economist, said: “The increase in discount rate is not an effective move to check inflation.” He argues that a long-term credit demand is not much interest rate-elastic meaning that a mere change in the interest rates cannot alter the pace of long-term credit growth. As for the short-term credit, particularly the consumer-driven credit, Dr Sayeed says that it is still responsive to the changes in interest rates and if eventual interest rates rise with the increase in SBP discount rate, growth in this kind of credit may slow down.
That is where discount rate hike may play a role in containing inflation.
“But the problem is,” points out another independent economist Dr Javed Akbar Ansari, “interest rate changes may not be very helpful in checking imported inflation, which has been at work in the present cycle of increase in inflation.”
Cut through jargons it means that since the consumption of imported goods has been on the rise and domestic production is not growing at the same pace, the resultant increase in the value of imports is bound to fuel inflation further.
“Besides, the discount rate is no more effective as the anchor of the monetary policy. What is effective is the inter-bank rate. So an increase in the discount rate may not necessarily lead to the desired pace of increase in eventual interest rates and dampen credit growth, which is necessary to hold inflation down,” says Dr Ansari.
Top bankers do buy this view. “It is not the discount rate but six-month treasury bills rate that has emerged as the new anchor of monetary policy capable to change credit growth pattern,” says Pakistan Banks Association Chairman Shaukat Tarin. “So, if the central bank is serious in combating inflation it should rather increase six-month T-bills rate a bit more aggressively.”
The reason why Mr Tarin and other bankers regard six-month T-bills rate as the new anchor of the monetary policy is that it is a key determinant of six-month KIBOR. And six-month KIBOR serves as the base for pricing short-term private sector credit. So the pace of credit growth can be changed only if six-month KIBOR shows a change.
The private sector credit has been growing at the fastest pace and in less than nine months of this fiscal year, total disbursement of the private sector credit reached Rs348 billion, just shy of touching the revised full year target of Rs350 billion. Initially, the government had estimated the private sector credit growth of Rs200 billion for this fiscal year, but as the economy itself is rising faster than projected, the private sector credit is also growing faster than targeted.
The central bank says Pakistan’s economy may grow by 7.4-7.8 per cent this fiscal year, against the initial target of 6.6 per cent.
Apart from higher-than-projected economic growth, what else is resulting in unprecedented expansion in the private sector credit is that real interest rates are negative, luring many into speculative activities.
At the end of February, banks’ weighted average lending rate stood at 7.08 per cent, far below inflation of 9.95 per cent during that month. That the SBP needs further tightening of interest rates to fight soaring inflation is also evident from the fact that weighted average yield on six-month treasury bills is lower than even core inflation, points out Mr Tarin.
During July-February 2004-05, core inflation or inflation that is responsive to changes in the monetary policy was at 7.13 per cent, whereas six-month T-bills yield stood at 5.5 per cent at the end of March.
