The recent cut in the interest rate by the State Bank of Pakistan (SBP) is well-calculated and well-timed. The 200 basis points cut in the central bank’s key policy rate — from 19.5 per cent to 17.5pc — is neither too small to make any impact nor too large to let inflationary pressure build up again.

But will it help revive industrial production? And will the recent trend of slowing the inflation rate continue?

Well, the answer to the first question depends largely on how long the ongoing increase in electricity and gas prices continues and whether Pakistan can get enough external financing soon.

The National Electric Power Regulatory Authority (Nepra) has recently approved yet another upward adjustment of Rs1.74 in per-unit electricity price and gas tariff may also increase after a while to contain circular debt of the gas sector.

Unless commercial banks that have made windfall profits prioritise lending to SMEs, an interest rate cut wouldn’t help them

However, a possible reduction in imported fuel oil prices in mid-September may lead to a reduction in transportation costs of businesses or at least keep them stable. In the last fiscal year that closed in June, large-scale manufacturing output grew just 0.92pc, throwing tens of thousands of industrial workers out of jobs and leading to full or partial closure of hundreds of industrial units.

The country cannot afford further closure of industries and further job losses in the current fiscal year. Nor can it afford deceleration in the growth of industrial exports amidst a severe foreign exchange crisis.

A straight two percentage point cut in interest rates falls short of the expectations of industrialists, particularly textile industries that are braving an additional crisis of 60pc fall in local cotton output in addition to higher energy costs. Nevertheless, it will help some industries, including textiles, keep their cost of borrowing under check and enable others, like petroleum processing and automobiles, to expand.

Demand for automobiles has rebounded recently, and as the economy is set to grow a little faster than in the last year (3.5pc vs 2.4pc), the demand for petroleum processing is also expected to rise. The interest rate cut can potentially help small and medium enterprises (SMEs) as well, more so as the government and the central bank have recently introduced a financial package to boost their output.

A straight two percentage point cut in interest rates falls short of the expectations of industrialists, nevertheless, it will help some industries keep their borrowing cost under check

Unfortunately, unlike large industries, regular SMEs continue to struggle with their unique problems of very low formal bank financing and extremely tough competition from small and medium-sized businesses operating in the undocumented economy.

Unless commercial banks that have made windfall profits through excessive investment in government treasury bills and bonds prioritise lending to SMEs and unless the government finds practical ways of documenting hitherto undocumented SMEs swiftly, an interest rate cut wouldn’t help regular SMEs much.

During the first two months of this fiscal year (between July 1 and Aug 30), the federal government’s borrowing from commercial banks totalled Rs660bn, less than what it had borrowed (Rs1.59 trillion) in the same period of the last year. If this trend holds on, and banks begin to lend freely to the private sector, only then can one expect industries and businesses to take real advantage of the cut in interest rate.

The SBP has said in its Sept 13 monetary policy report that annualised headline inflation eased to 9.6pc in August from 12.6pc in June due to contained demand, favourable global commodity prices and delay in upward adjustments in administered energy prices. And it has rightly warned that the near-term inflation outlook is susceptible to some risks.

The most obvious of them, as we all know, is the implementation of the energy price hike plans that were delayed at the time of the presentation of the federal budget in June. Any additional taxation measures that may be taken to meet revenue shortfalls may also affect inflation in the short term — a fact acknowledged by the SBP.

Regardless of how much and how quickly the lowering of interest rates may benefit the private sector, it will surely help reduce the government’s ever-growing cost of domestic debt servicing. (Domestic debt servicing alone eats up 54pc of the government’s total annual revenue, including tax and non-tax revenue).

It will also help the government contain the rupee cost of servicing its external debt that also devours an additional 7.5pc of the total revenue. These percentages are based on last year’s budget. The logical way to keep them from rising further is to stop additional borrowing but that is practically not possible.

Thanks to contained aggregate demand in the economy (though at the cost of massive joblessness), inflation has started easing, and that has made monetary easing possible.

The cost of external debt servicing can be kept under complete check only when the interest rate is low and the local currency’s outlook is also stable.

Published in Dawn, The Business and Finance Weekly, September 16th, 2024