Should interest rates be raised?
By Shahid Kardar
TO say that these are not normal times would be an understatement. The world has turned topsy-turvy in just a matter of months. To address this turmoil and with recession beginning to bite governments, states have launched policies that run contrary to conventional norms and standard prescriptions of fiscal prudence.
Despite the already large budget and external trade deficits and high snapshot rates of inflation, interest rates are being cut further (even when there is little left to cut) and government spending is being increased to stimulate the economy.
With such developments in the rest of the world, sharply declining international prices of commodities and faltering demand for goods and services, two recent decisions of the Pakistan government to rein in demand have evoked a strong reaction from business circles. These moves pertain to the raising of the discount rate by 200 basis points and the harsh upward revision of the electricity tariff by an average of 35 per cent (temporarily postponed).
Businessmen complain that these measures will impinge on industrial competitiveness at a time when international demand is plunging and they are also facing severely curtailed domestic demand. They fear that by adopting a strategy running counter to what the rest of the world is doing, the government could damage the manufacturing and financial sectors irreversibly as firms close down and credit defaults soar.
If we view matters dynamically (the speed with which the landscape is changing makes even a week seem like an eternity) the impending increase in the electricity tariff will be tricky to defend and even tougher to sell politically. With the price of oil having slumped from $147 per barrel in July to under $45 when the anticipated revision in electricity prices assumes an oil price of $108, the increase is ostensibly to cover Wapda deficits accumulated when oil prices were high. Consumers, industry and agriculture are to be penalised for past government failure to adjust prices in a timely fashion.
There is no denying that there is a huge hole that the government wants to fill but this could be difficult for the manufacturing sector precisely when there is an international recession, demand is contracting and costs critical for maintaining competitiveness and exports are rising. The rise in the cost of utilities and credit and in recent days the upward movement in the value of the rupee is bound to affect exports significantly.
The decision of the State Bank to raise the discount rate by two percentage points (with an increase of an additional 150 basis points programmed for January/February under the agreement with the IMF) is supposedly to restrain private demand (although that may not happen if banks decide to reduce their spreads) thereby also tapering the trade deficit, reducing the pressure on the rupee and easing the inflationary stress in the economy.
It has been argued before in these columns that our massive current account deficit and high domestic inflation has not been entirely on account of the rapid increase in commodity prices (especially oil). The blame for much of our misery can be laid at the government’s door (especially the previous regime). Loose monetary policy, populist reckless government spending, liberal inflows from external sources (thanks to 9/11) and massive volumes of liquidity in international financial markets kept the rupee overvalued and allowed aggregate demand to grow faster than the domestic production. This resulted in domestic inflation and rapidly widening trade deficits.
Since these imbalances were not corrected on a timely basis the chickens have come home to roost and we are now implementing an IMF programme, which surprisingly is less onerous than certainly this writer had envisaged.
This writer would propose a different approach to constrain aggregate demand — which has been the villain of the piece — than jacking up interest rates. The inflationary impact of more than Rs1tr borrowed by the government from the State Bank has already been set into motion and can only be corrected over the next 12 months or so.
Moreover, while accepting that in real terms interest rates are presently negative they are only so in the static sense because inflation is expected to fall with the dramatic decline in commodity prices.
To curb demand government expenditures need to be slashed by setting the budget deficit target at less than four per cent of GDP instead of the 4.3 per cent agreed with the IMF.
This would have to be achieved by cutting development and non-development (especially defence expenditures) drastically, since it would be a daunting endeavour to mobilise large amounts of additional revenues from a beleaguered industry over the next 12-18 months — it would be a folly to look at tax receipts during the first four months as representing a trend for the remainder of this and the entire next year.
Next, to contract private demand the preferred strategy should be to impose regulatory/excise duties and LC margins on finished goods as temporary administrative measures (these being bad policies to be pursued only in the short term) and allow the rupee to depreciate (being mindful of its inflationary impact).
Finally, we should be examining events dynamically with things changing at lightning pace. The trade deficit should narrow quickly (unless exports collapse) with import prices of commodities plummeting and a depreciated rupee and regulatory duties depressing demand, all helping to decelerate inflation speedily.
Therefore, in this writer’s opinion the decision to raise interest rates could turn out to be premature. It has not only created panic in credit markets but it is also likely to be unnecessarily painful (and perhaps even more costly politically) as the economic outlook darkens, business investment plans are shelved, industries begin to close and job opportunities shrink.


Acidity threat to oceans
By Ian Sample
THE world’s oceans are becoming acidic more quickly than climate change models predict, according to scientists who claim it will have a dramatic impact on marine ecosystems.
Water samples collected around an island in the eastern Pacific over the past eight years showed seawater had acidified more than 20 times faster than scientists expected.
The effect could be devastating for shellfish and other crustaceans, because acidic waters dissolve calcium carbonate used by the organisms to make their protective shells.
Oceans absorb about a third of the carbon dioxide released into the atmosphere by human activities. When the gas dissolves in water, it forms carbonic acid, which alters the ocean’s delicate chemical balance.
The increasing acidification of the oceans is likely to have impacts that run throughout the marine ecosystem, because the organisms most affected are at the bottom of the food chain.
Timothy Wootton, a biologist at the University of Chicago, led a team of researchers who analysed the acidity, salinity and temperature of water around Tatoosh Island off the north-western coast of Washington state.
Over eight years, the pH level of the water fell by 0.36 to about 8.1, more than 23 times more than the predicted fall of just 0.015 points. Water is neutral if its pH is seven, and becomes more acidic as the pH falls below that.
Writing in the US journal Proceedings of the National Academy of Sciences, the scientists raise concerns at how rapidly the process is happening and the impact it could have. “Acidification may be a more urgent issue than previously predicted, at least in some areas of the ocean,” the authors write.
According to computer models of the local marine life, the rise in acidity is likely to cause substantial falls in the numbers of mussels and large goose barnacles, while algae and populations of smaller barnacles may increase.
In turn, the changing distribution of these organisms will have effects on marine life that feed on them.
Last month, researchers warned that a new global deal on climate change would come too late to save many of the world’s corals. A report from the Carnegie Institution at Stanford University in California found that carbon dioxide emissions are likely to acidify seawater enough to cause widespread damage to major reefs, including the Great Barrier Reef in Australia. Even stringent cuts designed to stabilise greenhouse gas levels still put more than 90% of the world’s reefs in jeopardy.
— The Guardian, London


