In a recent earlier article, it was hypothesised that for a vast majority of sensible people on the planet, monetary policy is perhaps a proverbial black hole; accordingly to say that its, monetary policy, application in the context of Pakistan's economy is perplexing for the layman is perhaps a gross understatement. On a lighter note, monetarism might pretty soon feature in a Bond movie, with ominous men twirling their moustaches as they sit in their Ivory Tower plotting global chaos, not for any personal gains but simply because they are bored, and because they can do it; with Quartermaster at the Q branch scratching his noggin, "James, I have no idea what the hell is going on!".
The apparently magical powers of interest rates to grapple inflation until the former throws in the towel are what legends are made off. Albeit, the fact that inflation is different for different classes of society is a debate which the CPI, an average of averages of a selected basket, is not geared to handle. Forget what the rich think is inflationary, even middle class inflation is different from the poor class, and also varies between the urban poor and the rural poor. If a democratic government's target is the poor man's inflation, than they need some other magic than interest rates alone.
Nonetheless, whether or not these magical powers of interest rates are for real, is perhaps a debate even in the case of developed nations. In the case of a developing nation, where it is suspected that the size of the informal economy is equivalent too, if not bigger, than the size of the formal economy, these magical powers surely loose their efficacy. And whilst every decision to move interest rates must assuredly be supported by detailed econometric models which project the desired outcome, notwithstanding that these models and their related fantastic assumptions are by and large unintelligible to mere mortals, economics historically really does not enjoy a good reputation as far as predicting the real world goes.
Ignoring the debate relating to the effectiveness of interest rates to curtail poor man's inflation, and also ignoring that a vast majority of Pakistanis in any case do not even have access to banking facilities, rising interest rates still have multiple consequences. At the current levels, which are considerably higher than a year ago, the likelihood that domestic entrepreneurs will borrow for much needed capital investments is remote, if not improbable. Already challenged by comparatively higher energy costs and unbridled competition from perhaps superior imported goods, higher financial costs may well be the deal breaker for much needed investment in manufacturing projects.
Interest rates invariably drive up construction costs as well, making it difficult for citizens to buy houses, which they can't already buy in the first place. Because of a rather curious taxation policy relating to determination of capital gains, real estate is the investment of choice for all kinds of legal and illegal liquidity, which consequently has driven home prices beyond the reach of salaried citizens. Further, higher interest rates make it all the more impossible for salaried citizens to acquire mortgage financing, which in any case already has a low penetration due to multiple reasons, including clear title of land. Higher interest rates do not bode well for Naya Pakistan Housing Program. In fact higher interest rates will have an adverse impact on all kinds of consumer financing, including automobile financing, albeit some might take it as a positive considering the load on the road network and rising motor spirit imports.
Surprisingly, even the Government, who by the way is responsible for determining interest rates, will be struggling to meet its increasing debt service obligations; except, even in that case the burden will eventually be passed on to the citizens in the form of more taxation.
On the flip side, higher interest rates reward those who save for a rainy day. Savings are critical for a developing nation like Pakistan since you can only invest from what you save. By the way, higher interest rates also have a positive impact on the net interest spread of banks and they are set to make higher profits in the coming year with perhaps a consequent uptick in GDP growth. Most likely there are multiple other consequences of higher interest rates on the formal economy and perhaps indirectly on the informal economy, however our concern should be the ultimate balance.
What exactly is the interest rate level at which savers save more and domestic entrepreneurs borrow more to invest, and citizens can own houses, and the government does not have to tax us more to pay a higher interest cost? And inflation can go suck a lemon. Don't look at me for an answer; I am as ignorant as the rest of us about monetary policy!
Unfortunately, it appears that interest is a zero sum game and the masses are always on the wrong side of the equation. But if monetarism does not have an answer, the Government needs to focus on other policy incentives which achieve the ultimate balance; more savings and hence more investment.
(The writer is a chartered accountant based in Islamabad. Email: syed.bakhtiyarkazmi@gmail.com)