That the State Bank of Pakistan’s Monetary Policy Committee would but its benchmark interest was inevitable, considering the continued decline in the inflation rate, which is expected to keep on going down for couple of months more, before it starts picking up once again. When inflation in December clocked in at 4.1 percent, the lowest in 40 months, the only question that remained was how deep the MPC would cut interest rates. Even Prime Minister Shehbaz Sharif got in on the act, expressing the hope for a rate cut, in line with the business community’s hope for single-digit rate. As it is, the cut of 100 basis points brought the rate down to 12 percent. This has meant that the interest rate has come down 10 percent in the last year, from the peak of 22 percent.
The business community might insist on a single-digit rate, but the MPC is clearly being cautious, and bringing interest rates slowly, so that inflation does not come roaring back. One of the primary considerations for the government is what this means for its debt servicing obligations. Certainly, it is going to achieve major savings on debt servicing. However, that windfall is being frittered away by the FBR, whose shortfall in collection is about equal to the fall in debt servicing, which means the budget deficit will remain about the same. The fall in inflation is contributing to the shortfall, for the revenue target was set on the assumption of a certain nominal growth in the GDP. That growth will now be lower. Then there is the effect on the stock market, which should go up, as the reduction in the interest rate lowers the return on fixed-income investments and makes dividend income appear more attractive. Of course, it will probably men lower SBP profits, meaning that the windfall the government got this year will no longer be available.
In theory, interest rates should be brought down even more. However, one worrying sign is that even though interest rates have been almost halved this year, they have not translated into the sort of economic stimulus they should. The boost to the economy by the fall in inflation has also not led to the increase in employment predicted by economic theory. The government needs the voter to feel that his or her life has improved, and that will only happen when disposable income increases for longer than it has. It seems that at present, the damage to consumer and investor confidence caused by past inflation has been so great as to hamper any recovery.
