The State Bank will be in a quandary to maintain the interest rate at 7% to target economic growth or increase it to control inflation when it announces monetary policy on Monday. Experts are also divided what line the central bank will take – induce economic growth or control inflation.
According to a survey of 68 experts conducted by Topline Securities, 65% of the respondents say the interest rate will be maintained at 7%. The remaining 35% of respondents say the policy rate will be increased with a majority among them saying it will be increased to 7.25%.
Topline Securities CEO Mohammed Sohail say the central bank may opt to increase the policy rate to 7.25%.
“Besides high current account deficit in August, inflationary pressure is also rising. The latest inflation figures show an increase of 14.3% as compared to last year. It’s time for (monetary policy) tightening,” he said.
However, other experts think the policy rate will be maintained as the government targets growth and threats persist for the economy.
“The factors that caused the reduction in interest rate last year still exist,” said senior research Analyst Raza Jafri. “Threat of coronavirus is still there and winter is also just around the corner.”
Cold and less humid conditions make coronavirus more threatening, he said.
Jafri added that the country is yet to recover from the pandemic and he expects the central bank will not raise interest rates in this monetary policy.
According to another senior research analyst Adnan Sami Sheikh, interest rates are likely to be maintained as inflation is likely to fall below 8% in the next three months. He added that if the central bank raises interest rates, the economy will come under pressure and then the government will have to lower interest rates to induce economic growth.
In the Topline Securities survey report, 54% of respondents say the interest rate will be jacked up by the end of the year. The State Bank will be announcing this year’s last monetary policy in November.
In the survey, 57% of the respondents see the dollar rate within the range of Rs165 and Rs170. But 39% of the respondents see the range of dollar rate rising between Rs170 and Rs175.
The monetary policy is announced every two months. The next monetary policy will be announced on November 26 of the current financial year.
It should be noted that in March 2020, the interest rate was at a high of 13.25%. But the coronavirus pandemic and the deteriorating economy forced the State Bank to reduce the interest rate to 12.5% in March 2020 and then another 3.5% percentage points to 9% in April. Later, in June last year, the interest rate was further reduced to 7%. The State Bank has not raised interest rates in the last five monetary policies.
What role does the policy rate play in Pakistan’s economy?
Controlling inflation and ensuring economic stability are two of the State Bank’s core functions. To achieve these goals, the central bank uses, among other tools, its policy rate. This is the rate at which commercial banks borrow money from the central bank’s discount window.
The rate, revised every two months, affects every interest rate in the market. In other words, a higher policy rate means commercial banks will charge more, making borrowing more expensive for individuals, businesses and the government.
Higher interest rates make loans expensive. Businesses, which rely on bank financing, stop new projects, the government cuts spending on development projects, and consumers stop using auto finance, home loans and even reduce credit card use. In a nutshell, a higher interest rate shrinks economic activity and slows down job creation.
On the other hand, a lower interest rate encourages people and businesses to borrow more, which in turn increases consumption on the national scale. Since the overall demand is high, it makes the prices of goods rise, thus inflation increases.
The role of the central bank is to maintain the interest rate at a level that keeps inflation in check while also not reducing economic activity.
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