The absolute catastrophe that will unfold if Supreme Court changes interest rates

• The SC petitioner is a regular guest on television shows where anchors give him free rein to express his views on economic policies without ever drilling down the derivative consequences of his proposals.
• Many corporations that are currently demanding the lowering of interest rates are also likely to hold back investments given the uncertainty of the monetary policy.
• Should the Supreme Court take up the case, international investors may want to withdraw their investment given the potential of imposition of capital controls as proposed in the petition.

With SBP policy rate at 13.25%, and borrowing costs for many businesses well above 15%, there’s recently been an increasingly loud drumbeat demanding that the SBP lower interest rates. This has culminated in a former International Monetary Fund official filing a petition with the Supreme Court to order the authorities concerned to cut interest rate to save the government Rs1 trillion annually, and also place capital controls on withdrawal of portfolio investments in treasury bills. The petitioner pleads, “The court may kindly order the federal government to lower the policy interest rate to 6-7%, which will reduce the allocation of public funds for interest payments by about Rs1 trillion”.

The petitioner is a regular guest on television shows where anchors give him free rein to express his views on economic policies without ever drilling down the derivative consequences of his proposals. Given the latest petition to the Supreme Court of Pakistan, it might be useful to examine the petitioners proposal closely. However, before doing so it is important to note that commercial banks, like all other rational investors, look at real returns rather than simply focusing at nominal rates.  With SBP forward expectations of inflation at around 12.5-13%, and policy rate at 13.25%, real interest rate is positive but less than 1%.

If policy rates were reduced to 6% as proposed in the Supreme Court petition, the central bank would be providing a negative 6% rate of return. As banks margins get squeezed due to such negative returns, banks profitability would also be severely dented. Far from spurring on additional lending, banks might be forced to restrict credit growth, and also refuse deposits in order to shrink their balance sheets in an attempt to preserve capital. As banks withdraw from the lending business economic growth will suffer.

Ironically many corporations that are currently demanding the lowering of interest rates are also likely to hold back investments given the uncertainty of the monetary policy. Moreover, negative real rates are likely to further exacerbate inflationary pressures. Loose monetary policy pushes up consumption and thereby consumer prices. Also, it's likely to push up values of financial assets and high-end luxury goods, as well as create property bubbles. Asset bubbles and consumption-led demand may help certain businesses, but would result in persistence of inflation, destruction of the savings, and tepid long-term growth.

Moreover, increased domestic consumption will result in current account deficit, which the government has worked hard to curb, to once again burgeon to unsustainable levels. This will put pressure on the exchange rate. With rupee depreciating, reserves falling, and potentially capital controls in place, Pakistan is not only likely to see foreign investment into the country slow down, but potentially inward remittances from overseas Pakistanis also decline. Should the country go down that route it would soon find itself self-inflicting an economic crisis. Just when the country needs to integrate further the economy with rest of the world and participate in global value chains, artificially low interest rates and capital controls will force the nation towards being an autarky with all that entails.

Few things could be more dangerous than having negative interest rates in a high inflation environment that presently exists in Pakistan. It is also worth asking the petitioner the rationale for choosing 6% as the base rate. Given that the petitioner wishes SBP to abandon its effort at curbing inflation why not suggest a zero-interest rate policy (ZIRP). Also, the petition states in one place that interest rate have little or no effect on private sector borrowing, yet part of the petition submits that businesses, especially large-scale manufacturing, are contracting due to the rate hike. There appears to be a lack consistency within the petition.

While not wishing to sound alarmist, should the Supreme Court take up the case, international investors may want to withdraw their investment given the potential of imposition of capital controls as proposed in the petition. If foreign portfolio money were to suddenly exist, the Pakistan Rupee is likely to undergo a further round of depreciation. This will almost certainly be followed by inflation going up further. This is likely to push up interest rates.

Finally, it is worth reflecting on what would be the long-term consequences on the independence of the State Bank of Pakistan if the judiciary chooses to intervene in setting the monetary policy of the country.

Javed Hassan is investment banker who has worked in London, Hong Kong, and Karachi. He tweets as @javedhassan. The views expressed in this article are author’s own and do not necessarily reflect the editorial policy of Business Recorder