It was a surprising to read the Federal Information Minister Sherry Rehman's media briefing on the Federal Cabinet held last Wednesday. According to her, the cabinet has "decided not to increase interest rates further in the wake of slight deceleration in the rate of inflation". Since when has the Government eroded State Bank of Pakistan's exclusivity on monetary policy?
Fixing interest rates, exchange rates, regulating flow of credit and controlling the money supply in the economy form the core of autonomy granted in law to SBP. Has the legislature reversed it? Not to our knowledge! Raising the SBP policy rate last November was a controversial step.
It was a difficult sell for the Governor SBP as the economy was already slowing down and there were visible signs of inflation peaking and growing expectation of upward price spiral reversing itself. But decisions in the monetary sphere are not taken on the mere basis of perception. Real data is always needed to validate this. And time has to be given for monetary transmission to work itself through the financial system.
Further, this country has taken help from the International Monetary Fund. Monetary and fiscal policies have to work within a framework agreed with the Fund. SBP is expected to come out with a monetary statement at the end of this month. SBP itself can only loosen tight monetary policy, after a review by the Fund staff, and upon reaching an understanding with the Fund.
One can only hazard a guess. During the discussion seeking approval of the Medium Term Budgetary Framework, by the Federal Cabinet, some ministers might have raised the issue of high interest rates. Businesses are suffering due to abnormally high lending rates and there is a clamour from trade and industry for a reduction.
Advisor to the Prime Minister on Finance Shaukat Tarin may have addressed this concern. Tarin needs to make clear to his Cabinet colleagues that fixing interest and exchange rates are outside the powers of the government. And, in case the Advisor did express his optimism about the possibility of rates coming down as inflation has peaked, the Information Minister should not have gone public.
Multilateral lenders are very sensitive when it comes to such issues. Fund wants to ensure that the interest rates in Pakistan be real while exchange rates are market based. Artificial construct won't work. The bidding in the auction process for the government paper must reflect ground reality. The auction bid amount and yields for Treasury Bills reflect the liquidity in the system.
And, the auction of Pakistan Investment Bonds is indicative of interest rates. At present, banks are aggressively opting for investment in government paper. Bank holding of T-Bills has gone up over 400 percent in one month by Rs 235 billion above the statutory requirement.
This jump would be helpful in shifting government borrowing from the State Bank to the banks. And, could somewhat ease the inflationary pressure. However, it is crowding out the availability of credit to the private sector and keeping the lending rates high. This is causing a slowdown of the engine for growth of the economy. Credit needs to flow freely at affordable prices to turn in the economy.