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Formulating a realistic monetary policy

Published on 19th Jan, Edition 3, 2015


The monetary policy has been misused to a large extent. There was exploitation of the depositors’ money by the rich and powerful class in the absence of an effective central bank. The government enacted laws to give autonomy to the SBP in conducting an independent monetary policy in coordination with, rather than in subordination to fiscal policy, and to make the SBP the exclusive regulatory authority over the banking system. The SBP board of directors was given complete autonomy to formulate and implement monetary policy under the guidance of its governor. The governor provided statutory protection of tenure so that the government could not use its authority to remove him on policy differences or on disobeying an unlawful government order.

The legal and institutional framework was followed during 1997-99 in the formulation and implementation of monetary policy, and operational autonomy of the SBP was ensured within its jurisdiction. The SBP also played an important role in the macroeconomic management of the country. The two so called democratic governments have taken steps to further bring the SBP and monetary policy under de facto control of the finance ministry without changing the laws.
From 1992 until 2012, Pakistan Interest Rate averaged 12.8 percent reaching an all-time high of 20 percent in October of 1996 and a record low of 7.5 percent in November of 2002.

All over the world the interest rates are declining and in some countries it has gone to even zero level while remains very low in the region including India, China, Sri Lanka, Bangladesh and other countries.
After the winding up of PICIC, IDBP and NDFC and the absence of full-bodied bond and equity markets, the task of responsibility of providing long-term credit for financing has been given to our commercial banks. These institutions unfortunately are still not well equipped to take such a strategic role of providing long-term credit facilities to private stake holders.

It is keenly observed that our banks usually favor lending to the sovereign and holding government securities instead of extending credit facilities to the private sector. Pressure is always brought to bear on banks by the government to lend to the power sector and to all the major participants in the energy sector to help cut down the size of the circular debt problem. Private sector borrowing in Pakistan remains still very low as banks prefer lending to the government and a hike in the interest amount to punishing the private sector as they would have to pay more interest on borrowings.

The State Bank of Pakistan for a long time has been following a tight monetary policy to control inflation. Even then it has not been successful in pressuring the government in grooming the economy. State Bank of Pakistan must order commercial banks to narrow down the gap between lending and deposit rates for providing better returns to the depositors and encouraging savings.
At present there is a need of adequate credit from the banking system and at a price that makes business and industrial operations feasible.

The government should take business community on board prior to taking such decisions having a direct impact on the cost of doing business. The availability of surplus liquidity in the market has been always essential as its absence was the prime reason behind lack of investment in the industry. Reduction in bank mark-up rate could encourage fresh investment in the industry, particularly in the textile and other industries. Borrowing remains still very low as banks preferred lending to the government and a hike in the key policy rate tantamount to punishing the masses and the private sector as they would have to pay more interest on borrowings.


If the policy rate remains at the same rate the cost of doing business will increase and there are chances of large default by businessmen, making it difficult for businesses to clear their liabilities. The higher rate of doing business will affect the profitability of the small and medium size companies. It is seen that net borrowing by the private sectors from the banks is insignificant. The high cost of doing business combined with high inflation rate discourages the purchasing power of the potential customer. The higher rate of interest, net investment in the Islamic Banking Industry declined and the non performing financing in the Islamic Banking industry increased during the quarter, resulting in an increase in provision against financing.

On the other hand, the reduction in the interest rate shall improve the economic activity. It will encourage the SMEs to bring larger upliftment to the country. There is a great need of encouragement of “Asset Based Financing” through “Leasing Sector in Pakistan”. The leasing sector has been an essential arm for the development of the progressive growth of the country. Higher cut in the interest rate could bring visible growth in economy as cheaper money could immediately accelerate investment. Our infrastructure is in a broken down condition, cheap term project financing by lower interest rate is essential for the speedy growth of road and railway networks. The financing of solar panels should be allowed with cheap rates to the energy burden on utilities and national grid. Banks should create space for a business to borrow as private sector financing is almost minimal. Trade deficits are widening. A lower interest rate will help significantly reduce the balance of payment.

While formulating a realistic monetary policy, the SBP should come up with estimates of credit requirements of the private sector that would help achieve the growth target for the next fiscal year without fuelling inflation. The federal government is required by law to adhere to its borrowing limits from the SBP as agreed with the SBP/imposed on it by the board of directors of the SBP. The provincial governments should not be allowed to borrow from the SBP except for self-liquidating ‘ways and means’ advances. Government borrowing from commercial banks should be more flexible. But such borrowing has to be done within the broad limits dictated by monetary policy considerations and through an auctioning system conducted by the SBP. It may be added that the IMF also recognizes that monetary policy and the SBP need to be freed from the handcuff of the Ministry of Finance.

In this state of affair it is the responsibility of the government to reduce the high banking spread and cut down the mark up rates to encourage savings, investment and easy credit facility for growth of business activities. Banks are seen to be earning substantial mark-up income on the basis of high spreads and high interest rates, which is not a good sign and not considered a prudent approach to encourage the development of private sector in the country.

High interest rates are putting hurdles in developing economy. The interest rate should be brought down to a level of interest prevailing in the competitive regional countries. The high interest rate is the major reason behind the decline in the country’s industrial output. The downfall in auto, textile, electronic, petroleum and other key sectors adversely affected the performance of large scale manufacturing (LSM) in the country.

Exporters are facing a lot of difficulties due to high cost of production. Cutting interest rates to a reasonable limit will produce multiple benefits for the economy, as it will lower the cost of doing business, give a strong boost to business and industrial activities, provide easy credit and loaning facilities to trade and industry, promote better investment and exports and generate more tax revenue for the government.

Pakistan is seeing a steep decline in private sector investment and it is the high time that State Bank of Pakistan should change its tight monetary policy once for all and bring down discount rate to promote the private sector investment and growth of industrial and business activities. It should practically monitor and check the operation of macroeconomic policies of the government rather than often announced monetary policy in a routine manner with so much of publicity.




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