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How interest rates can help the country achieve a positive GDP rate?

Published on 19th Jan, Edition 3, 2015

 

With the new year having started, the prospects of the banking sector in terms of growth are looking bright. However, the question, which must be looked into is whether or not these banks will be able to help the government during its 5-year term and help the economy in achieving growth by helping the business and industrial sectors in particular. For high rates of growth to be achieved in an economy, there is a need for a low rate of interest and a banking system, which is responsive.

The main agenda due to which the PML-N government managed to come into power consisted of helping the country rid itself of its energy crisis and to increase the rate of GDP. Growth was and is expected to be achieved, corruption ended, creation of jobs for those unemployed as well as keeping in check the level of inflation.

Banks in Pakistan continue to be profitable, being managed by professionals and are ranked highly by the Karachi Stock Exchange as well. In the last few years however, these banks have begun to opt for lending, which is aimed to the government as it is a safer, large scale and profitable form of lending for them. Four governments including the PML-N government at present have borrowed money from banks to deal with the budget deficit they face. With a 13% interest rate being paid and loans being state guaranteed, this caused the economy to stagnate and caused the GDP to fall down to 2.5% annually from the 6-7% which was being achieved back in 2006. Furthermore, lower demands for funds from banks as well as an increase in non-performing loans due to commercial and industrial borrowers defaulting on their payments caused additional troubles for the economy. This preference of lending solely to the government is something, which certainly allows these banks to remain in their comfort zone and while this trend seems as though it will continue despite on a lesser scale, banks need to begin lending to others in the private sector as well.

For banks to not only sustain the profit levels they achieved in 2014 and for the growth rate of the economy to rise further, lower interest rates need to be offered along with other parties apart from the government being the recipient of these loans. The preference of banks to lend to governments on a large scale basis is evident from the investment of commercial banks in government securities rising to Rs4.4046 trillion in June 2014 compared to Rs1.368 trillion, which was recorded in June 2012. In comparison, the stock of lending by commercial banks to the private sector increase by only 34% from a value of Rs2.058 trillion in June 2012 to Rs2.765 trillion in June 2014 making the gap and preference quite apparent.

Reducing the interest rates offered by banks could help in allowing economic activity to increase and to move towards growth. With high business costs and inflation rates, purchasing power of customers is weakened and by getting the opportunity to take out loans with ease will not only help these consumers but help the economy in general.

 

With regard to the monetary policy, which is to be announced, the SBP has been requested to bring down the interest rate to a single digit i.e. to 7% preferably, which would be a reduction of 2.5%. If this is not done, cost of doing business will continue to rise and could cause a number of businesses to default which would make it even more difficult for liabilities to be cleared by them.

Furthermore, the high rates of doing business also negatively impacts SME’s which further doesn’t leave chances for businesses to compete on an equal basis. To improve matters, the economy can gain from the small and medium sized companies were the interest rates reduced.

By reducing interest rates, growth would further be achieved with increases in investments. The country’s infrastructure is one which would greatly benefit from such a reduction as cheaper projects would become a possibility and would allow the road and railway networks for example to be brought up to mark. At the same time, the leasing sector should also be taken into consideration with respect to the benefits a lowered interest rate would bring to the country. The leasing sector is essential and plays a vital role in the development of the country, however, high interest rates affect the equity, booking of profit and recover of such companies in comparison to the losses.

Were the interest rates to be brought down, the possible reduction could allow the country’s debt servicing to be brought down to Rs130 billion in the current fiscal year for both domestic as well as external loans. The equity market as well will benefit positively from this reduction. It will bring about a positive impact on those investors looking for results but will also encourage banks to lend more to the private sector, something which they have not been engaging in. this will further cause investments and growth to occur in the economy. Apart from the reduction in interest rates, there is likely to be another factor at play which will positively impact the equity market and this would be the consensus reached by the military as well as the political domains to fight against the ongoing terrorism which will help in creating and furthering a positive business climate and thereby attract more investment and business.
Thus considering the facts, it is likely that the reduction in interest rates could overall have a positive impact on the economy and would help the country in achieving its targeted growth rate of 5.1% for 2014-2015. Making the business climate one where businesses feel that they can invest due to the positive environment; by increasing the purchasing power of consumers; improving the equity market and lending to the private sector at a lower rate will all help the economy of the country to be steered in the right direction.

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