The world is evolving at a rapid pace and so is its economics. We live in a world today in which the cost of international financial transactions is so low that it makes a minimal difference to interest rates and asset prices between countries. This can be attributes largely to the advances in communication technology over the past 30 to 40 years. The velocity, volume and range of international financial transactions are unfathomable today. Today trading occurs 24 hours across the globe in real time.
Hyperglobalists argue that the rise of global private finance is simply the triumph of markets and technology: the high volume and rapidity of transactions, combined with innovations in financial instruments, swamp national financial controls, making them redundant.
However, one cannot deny the fact that banks and financial institutions rely heavily on national and international regulatory authorities for their effective operation. Commercial banks require central banks to act as lender of last resort to prevent bank collapses. This has been witnessed on numerous occasions in history. The debt crisis of the 1980s, the East Asian crisis of the 1990s and the ongoing financial crisis all show that when banks get into difficulties the most economically powerful state alongside international public authorities, such as the IMF, have to step in to prevent financial collapse.
The State Bank of Pakistan’s unexpected cut in its key policy rate by 50 basis points to 13.5 per cent recently has roused much debate in the economic circles of the country. A number of market participants and economists thought the bank would maintain its tight monetary policy until inflationary pressures subsided. The bank raised the rate by 150 basis points in the first half of 2011/2011 fiscal year and held it at 14 per cent in the second half, which ended on June 30, 2011.
However, according to recent data, inflation pressures are not subsiding. The state bank of Pakistan expects the inflation to go down to about 12 per cent in the current fiscal year from 13.9 per cent. More importantly while the overall inflation numbers may go down in the short-run, commodity prices are going to be sticky and will continue to squeeze the life out of the consumer.
This is because the main reason for such high inflation is the large increase in energy cost, especially in electricity and natural gas. Moreover, the government is heavily taxed at the moment with the subsidy bill for theses sectors which in turn is contributing to raise the price of energy even further. The main inflationary pressure in Pakistan comes from food prices and oil prices. Food and beverages have 40 per cent weightage in the consumer price index while fuel and transport combined make up 14 per cent.
This rate cut might not just be aimed at bringing down inflation, it also directly affects the money market, the market for short term loans. The interest rate cut could have been prompted by the fall in growth and investment that has become a cause for concern among policy makers of late. To state an example the textile industry contributed immensely to the record $25 billion exports, however the sector only grew by 0.6 per cent. There was also no significant increase in the volume of textile exports or investment in the sector. The overall growth was at 2.4 per cent in 2010 – 2011 fiscal year, against a target of 4.5 per cent. Similarly, large scale manufacturing growth was just 1.7 per cent from July 2010 through March 2011 as compared to the target of 4.9 per cent. The trade deficit is likely to increase on account of rising crude oil prices and falling cotton prices. In addition to that the economy will not have external funding which has kept it afloat so far.
With so many factors to account for, was decreasing the interest rate the best and only option the government had to control commodity prices? The answer is an emphatic no. First of all as acknowledged earlier a lot of the price pressure comes from external factors. In such circumstances the government should focus on narrowing the deficit by raising revenue and cutting spending. This will curb the need for printing more money. Policy makers in the government should realise that they have more cards on the table than an arbitrary interest rate to solve the country’s problems.
The writer is News Editor, Profit
Will tweaking the interest rate help?
