The State Bank of Pakistan hiked on Monday the key interest rate by 150 basis points (bps), taking it to 13.75%. This is a 11-year high level, and comes as Pakistan faces multiples economic battles.

However, what it does is add to your cost of doing business — directly or indirectly.

Suppose, you have an outstanding loan of Rs1 million. A 150 bps increase roughly adds Rs1,250 to monthly installments on just a Rs1m loan.

This is just the delta, or the change, or the increase in payment. Now, by no means, is this number 100% accurate, but gives you a rough idea on the kind of interest-rate burden a 150-bps increase places.

The yearly increase in payments for a Rs1m loan is Rs15,000, and takes total outstanding payable – not counting the principal amount – from Rs122,500 to Rs137,500.

Similarly, monthly interest payment on a loan worth Rs5 million surges by a substantial Rs6,250. On a yearly basis, it goes up by a significant Rs75,000.

SBP raises key interest rate by 150 basis points, takes it to 13.75%

Samiullah Tariq, Head of Research at Pak-Kuwait Investment Company, said this would significantly hike installment amounts for the people who have availed banks loans.

“However, we can call this increase temporary because once the central bank reduces the policy rate following stability and improvement in the economy, this amount will fall and installment payments may return to the same levels that people were paying prior to this increase,” he said.

In its statement, the central bank said that the rate-hike should help moderate demand to a more sustainable pace while keeping inflation expectations anchored and containing risks to external stability.

The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability and growth, it said.

Experts react as SBP jacks up key interest rate

How a rate-hike reduces demand

A rate-hike increases the cost of doing business, in the form of interest payments, with cash diverted to meeting bank obligations.

In such a scenario, businesses tend to divert resources to meeting the higher obligations, thereby investing lower than before. The same argument extends to consumers who spend less, in their effort to meet interest payments.

This lower spending/investments reduces aggregate demand, and moderates inflation — at least, theory-wise.