August 28, 2006	Monday	Sha'aban 3, 1427

BY raising the discount rate of the State Bank of Pakistan (SBP) for three-day lending to commercial banks from nine to 9.50 per cent, the bank signalled further rise in interest rates to combat the persistent inflation. And that is among the several steps taken by the SBP in a short time to move towards achieving the target of 6.5 percent inflation in 2006-07.

The SBP has also raised the ‘cash reserve requirement’ and the ‘statutory liquidity requirements’ collectively by five per cent. That means the bank will now have to keep 25 per cent of the cash deposits with the SBP. To that extent the ability of the banks to lend to the private sector is reduced and the tightening of the monetary control made more effective.

But the banks can make up for that through a vigorous drive for augmenting their deposits which means they will have to offer a higher rate of interest to the depositors than the nominal rates they have being paying for long.

A substantial rise in savings, preferably for long-term is also an anti-inflationary measure as it reduces current consumption. The increase in the discount rate and the cash reserve has also pushed up the Karachi Interbank Offered Rate (KIBOR) to 9.07 per cent per year and the three month rate to 9.77 per cent.

The SBP has also asked the banks to surrender to it the unclaimed deposits of account holders which have not been operated for the last 10 years with a few exceptions. The central bank has reaffirmed its earlier regulations regarding banks buying shares and come up with a few new restrictions.

At the same time, realistically the export refinance rate was cut by 1.5 per cent to counter the slowing down of the exports, while the exporters are clamouring for a larger reduction.

As a result of such steps to contain the bank credit to the private sector, the average short- term lending rate is 10.1 per cent so far, which may rise as a result of the measures taken by the central bank.

While the interest rates in Pakistan and other developing countries, including Latin America are high, the interest rates in the industrial states have risen but are still low. Their central banks while anxious to hold down the inflation are reluctant to further raise the interest rates for fear of hurting their economic recovery or growth.

The US Federal Reserve has raised its short-term lending rate to 5.25 per cent, apparently ending the rate rise of a quarter per cent each time that begin in 2004. The Bank of Japan has ended its zero rate of interest and come up with a quarter per cent interest. The Bank of England has raised its interest rate to 4.75 per cent and European Union has reluctantly raised its rate to three per cent lest it hurts its economic recovery. South Korea has an interest rate of 4.5 per cent.

India’s short- term lending rate is 6.34 per cent, while Pakistan’s lending rate is 10.1 per cent. China among the developing countries follows a far different approach than that of other developing countries.

With its economic growth in the second quarter of this year at 11.3 per cent, it is seeking a lower GDP rate and has reduced exports so as not to hurt its competitors. The Bank of China has increased its lending rate to 6.12 per cent and raised its deposit rate to 2.52 per cent. It has raised both the rates by uniform 0.27 per cent.

The difference between the lending rate and the deposit rate is large, more like what it is in Pakistan, but a government official in Beijing has explained that China does not want an increase in savings deposits now as that is likely to be converted by banks into loans which will go into investment and overheat the economy which it does not want now.

Spurning the demand of the US and other countries for a revaluation of the Chinese currency, he says that better results could be achieved by making money more costly and that is what China has done now, he argues.

Compared to China, which achieved a growth rate of 10 per cent for consecutive years, Pakistan has been faltering after it had achieved a growth rate of 8.6 per cent in 2004-05. The donors have been warning the government that unless it takes supportive measures and develops its infrastructure fast- particularly output of power- it will not be able to sustain a high growth.

An IMF review mission led by Mohsin Khan Director for the Middle East visiting Pakistan says that its current pace of investment is insufficient to keep its economic growth on track. It has urged further liberalisation of the economy for attracting more foreign and domestic investment.

The IMF also wants Pakistan to be more aggressive on the export front, particularly with its major partners to achieve its export target of $18 billion for the current year.

The mission pointed out the areas hampering foreign and domestic investment. Some of them are the slow pace of reforms initiated in all the key areas of the economy such as banking, judiciary, energy and electric distribution companies. Similar advice has been given repeatedly by the World Bank and the Asian Development Bank.

Compared to Pakistan which wants an 8-10 per cent growth for 10 years together, Malaysia seeks a sustained growth rate of 6.5 per cent for the next 15 years to achieve a developed country status by 2020.

The government has also been asked repeatedly for reducing the cost of doing business which means lower taxation in place of multiple taxation and elimination of the pervasive corruption. There is the urgency to cut down the red tape with its vast paper work which opens the door for petty corruption.

Above all, money has to be cheap as also power to promote long- term investment. The banks instead prefer short- term consumer loans at high interest rates.

Loans in retail banking rose by 115 per cent, while the number of borrowers rose by 95 per cent in the last two years says the banking ombudsmen Azhar Hamid because of the high interest payments they receive. The banks promote retail banking aggressively and fight shy of long- term investment loans at lower rates.

But now the SBP is considering a strategy to promote long- term loans for industrial development. Meanwhile, the loans are getting to be more costly because of the rising interest rates. But if large scale investment is sought and has to be sustained, the interest rates will have to be reduced, while relying more on the supply side to hold down prices and achieve 6.5 per cent inflation.

Total investment last year rose to 20 per cent of the GDP from 16-17 per cent. Efforts should now be made to raise the figure to 25 per cent of the GDP while conditions for more foreign investments are made more attractive.