With CPI sliding down to a single digit, this could be the most appropriate time for the State Bank of Pakistan to chop discount rate by 200-250 basis points. Due to high discount rate, the government has to pay nearly Rs 400 billion annually for issuance of government paper in the shape of T/bills, Pakistan Investment Bonds (PIBs) and Sukuk of nearly Rs 3.8 trillion.
Since MoF is left with no option and cannot pay back return on investments, it is compelled to rollover the government bonds by increasing government securities' target by 5 percent to 8 percent annually at the time of maturity. This outcome is because of a shortfall in revenue collection as the government is unable to pay back interest to bond holders due to scarcity of funds.
It is, therefore, important to understand that interest rate is an effective tool used by every Central Bank, to manage a country's economy. It is Central Banks' cardinal responsibility to stimulate economy when growth is on a constant decline. Lowering of rate becomes necessary to provide relief to consumers so that borrowers' debt payment is reduced to encourage businesses to borrow capital from banks.
Years of SBP's tighter policy stance have proved to be a futile exercise as our GDP growth is on constant decline due to commercial banks' prime interest in investing in government securities as scheduled banks' advances are almost at par with banks' investment in government securities. Banks are at high risk of being downgraded by rating agencies due to investment in government bonds.
SBP in last 5-years has never delivered any economy stimulation plan to support GDP growth or made no effort to force bank lending for new businesses to create jobs. Investments by banks in government securities will support my argument that it is now close to 40 percent. Instead our Central Bank has failed to arrest currency in circulation that has climbed to a whopping Rs 1.755 trillion, which should be a matter of grave concern. This is also one of the causes of rising inflation.
Central Banks create inflation with a view to mainly creating new jobs. Note-printing is now a common practice adopted by almost all the developed economies to counter deflationary times. The current biggest global financial worry is high debt that has gathered leaders and members of G-8 and G20 nations on one table to counter debt and stimulate their respective economies by reducing high interest rate to reduce borrowing cost. The damage is of such a high magnitude that world leaders are directly intervening and taking up matters to reduce risks and forestall the spread of contagion.
An European Central Bank, the Bank of England, Peoples Bank of China, the US Federal Reserve, the Bank of Canada, the Bank of Japan, the Swiss National Bank and many others have kept their interest rate at historic low supported by quantitative easing to ensure ample liquidity in market.
Like many other nations, Pakistan too is suffering from rising domestic/foreign debt and is without a blueprint, but no one seems worried about the consequences of maintaining a high discount rate, which is causing and will increase pressure on future financing unless revenue collection improves.
All that the government has to do is to ask SBP to stop administering injections of liquidity through its open market operations (current OMO injection of Rs 390 Billion), reduce the Pakistan Investment Bond Coupon Rate by 3 pct and inject liquidity, which will help rates come at par with market rates. Most importantly, the biggest discrepancy is the corridor floor rate, which is 3 percent below the discount rate; it should be removed as this is the thorn in the flesh of growth from all perspectives because banks are blessed with Central Banks' window as last resort to deposit their excess funds, which discourages lending to genuine commercial borrowers.
Since 2012-13 is an election year, this is an opportune time for the government to intervene like other global leaders do. The government is, therefore, required to effect a drastic cut in discount rate with a view to garnering the support of business community and consumers. A 100 basis points cut will be a token move, which will do no good to the economy. Nor will it give any comfort to debt planners.