Economic Impacts Of A 1.

5% Decrease In The Discount Rate And Future Expectations Of Discounting

The State Bank of Pakistan recently announced a decrease of 150 basis points in its discount rate for the next two months citing lower levels of debt and a decrease in the rate of inflation as the main reasons.

The cut can be attributed to the fact that on an overall basis, the government of Pakistan borrowed less then its agreed limit of $13.2 billion to currently stand at $12 billion.

The real beneficiaries of this cut would be businesses who had been paying extremely high amount of service costs on their borrowings in the past at 13.5%. Alongside them, the government would also benefit in terms of paying less for servicing its debt.

However, given the decrease in the discount rate, I still do not see how it would benefit the economy as a whole. There are two main points which need to be discussed here to clarify my argument. Firstly, a discount rate of 12% is far too attractive for banks to invest their deposits in government backed securities. Secondly, if close attention is paid to the lending graph of corporations during the last half decade, it has constantly been on the downfall as investors have been reluctant to borrow from banks (Carlberg).

The State Bank should have should have injected liquidity to support growth rather than cutting down on its discount rate. Doing so would have encouraged investment in government securities and reduced the amount of government borrowing, thereby resulting in lower servicing costs (Bayliss).

It is interesting to see how the Karachi Stock Exchange responded positively (both in terms of volume and trend) to the cut in discount rates. However, this bull trend doesnt appear to last for long since the market lacks liquidity.

Given the political situation of the country, the State Bank can be expected to keep the interest rates stable when it announces its next monetary policy. This can be understood as elections are just round the corner and such a decrease would definitely make the industrialists stand by the government as it prepares itself for elections.

References

CARLBERG, M. (2010). Monetary and fiscal strategies in the world economy. Heidelberg, Springer. http://public.eblib.com/EBLPublic/PublicView.do?ptiID=511691.

BAYLISS, L. (2010). Monetary policy recollections. Otaki, N.Z., L. Bayliss.