The slowing of inflation has caused the call for a lowering of the interest rate to grow louder, a step which the government has already backed, and which has now been suggested by the Coordinator of the Special Investment Facilitation Council, Lt Gen Sarfraz Ahmed. The State Bank of Pakistan’s Monetary Policy Committee may realize that keeping interest rates at 11 percent, when inflation has run for November, at 6.1 percent, marginally down on the 6.2 percent recorded for October. Apart from the increasing pressure for a further rate cut from the present 11 percent, the inflation figure indicates that the country is over the hump for the expected surge in food prices due to the floods. If indeed there was an effect, it has now passed through the economy without having caused any catastrophes. Another reason for looking forward to a rate cut is that it would reduce the government’s debt serving costs, and thus pressure on the budget.
It could be argued that the interest rate is now a victim of its own success, or at least in danger of so becoming, and causing inflation to set in, because players will try to take advantage of the gap between the interest rate and the inflation rate. The other danger is that the slowing down of inflation will lead to a disincentive for the banking sector, and too much easy money to be accommodated by the economy. Reducing interest rate will also lead banks to lend more cautiously. The main contribution of the government will be to refrain from using the easing to borrow more. Another factor leading to a predisposition to lowering the interest rate is the improvement in foreign exchange reserves. The net outflow of foreign direct investment shows that the interest rate is already not attractive enough to bring in FDI, which is not needed to shore up the reserves which are otherwise growing naturally. A cut in interest rates will only affect the foreign exchange reserves marginally.
The government to look over its shoulder at the IMF doubly. While it is IMF pressure that has given the SBP independence, and it has recommended that interest rates be kept high, it is now running out of excuses to prevent a stimulus to the economy. However, it can hardly be called a stimulus if a rate-cut is administered because the fundamentals favour it.
