The low interest rate challenge

The State Bank of Pakistan has reduced its policy rate by one percent or 100 bps; it has, however, protected the small saver by keeping the floor at five percent and slashing the rate only by half (0.5 percent). Priority, this move will primarily impact large network banks having a higher number of saving accounts. Mid-tier and small banks already pay a higher rate on saving deposits than the big five do; their deposits mainly constitute term and time deposits. The government would also lose some tax from big ones since their interest payments will be higher and lending rates lower than before, thus squeezing their profitability.

What is indeed baffling for us is the question why the Ministry of Finance decided to aggressively sell long-term bonds in a falling interest rate scenario. It should have been other way round, ie, sell less PIBs and more short-term treasury bills (T-bills) when lending rates are falling. Banks for the next two years have heavily invested into long-term bonds (PIBs) over and above their statutory liquidity needs; these would now benefit at the cost of the taxpayer.

SBP could reduce the policy rate because the overall economic scenario has improved for whatever reasons. With inflation on a downward slope, there exists adequate space for real interest rates to remain positive despite a 100 basis point cut. SBP has now signalled to banks that it does not intend to slash its policy rate further since international crude price have now stabilised around 65 dollars a barrel. In case of a 50 bps cut banks would have maintained a wait-and-see attitude. By opting to cut the policy rate by 100 bps SBP has indeed signalled to the market that they also intend to stabilise the rate. And, reducing the corridor width from 250 to 200 bps – SBP also seeks to address the interbank volatility. Its new policy rate – 7 percent – would now be the rate at which banks borrow from SBP; in case they deposit their overnight excess funds, they would only get five percent.

The government’s growing dependence on scheduled banks for its budgetary needs persist. SBP therefore is also forced to inject money into the system for settlement otherwise the financial system would choke and banks would be unable to settle at the end of the day. The government, therefore, needs to focus on raising more revenue and reducing expenditure by plugging wastages. Depending on provinces to generate surplus in a country where the social needs are so acute is being unrealistic. Slashing of public sector programmes, whether at federal or provincial levels – needs to be abandoned without any further loss of time. However, corruption and huge throw-forward of existing programmes need to be re-looked at. It cannot be business as usual if a change is needed. SBP has done its bit; it is now for the government to do what is needed. The situation brings to one’s mind the remarks of Nawaz Sharif that he famously made in response to high interest rate – 14 percent – during the tenure of the last PPP government. According to him, nobody can do business amid such high interest rates. He is now, therefore, required to ask Mr Dar to investigate why private sector borrowing is still quite low although interest rate has declined to as low as 7 percent.