Policy Rate and Inflation Control Fee Theory for Pakistan

Atiq Rehman:

Despite the fact that State Bank has fixed policy rate at 13.25, the trading in long term debt market is happening even at less than 10.5%. This means, if there was no indication by SBP, the equilibrium interest rate should be much lower.

Now, the market equilibrium is lower and all economists are asking to decrease policy rate. The expectation of inflation which is core excuse for keeping interest rate high, is coming down owing to the economic conditions in the international market. At this moment, a new excuse is developing to keep the policy rate higher, and this is, the hot money.
Foreigners have invested in Pakistani debt market to earn high interest, and by lowering the policy rate, it is expected that they will draw back money leading to depreciation. In fact, the depreciation is harmful for the investors because it will hurt their earning in terms of dollars. The benefits that we had in trade also support a strong rupee. Yet, poor management has caused depreciation in past week and will cause further depreciation in coming days. This will make a strong case for keeping interest rate high.
Though market is asking for single digit interest rate, the monetary policy committee will reduce it only by half percent or so. So, the nation’s slavery to the banks will remain intact…..
Written by: Atiq ur Rehman
Omar Javaid
“America had less than 1% policy rate for a long period and now it has 2.5% policy rate. This means, if America has a domestic debt of 1000 billion, it has to pay 25 billion as markup. United Kingdom has a policy rate of 1.5%, therefore, it will pay only 15 billion as markup on domestic debt of 1000 billion. Thailand has policy rate of 1.75% and China has a policy rate of 2.5%. On contrary, Pakistan has a policy rate of 13.25%, implying that we would have to pay 132 billion on the same amount of debt. So, the borrowing for Pakistan is much costly compared to the other countries.
What prevents us from choosing a policy rate equal to US or UK? It is the fear of inflation. Therefore, make it clear that the amount of 2531 billion that we have allocated for payment of markup on domestic debt, it is not the cost of borrowing, it is the fee for controling inflation. #Inflation_Control_Fee_Theory
Unfortunately, this #Inflation_Control_Fee is counterproductive and it increases inflation instead of reducing it. The higher policy rate translates into higher government obligations and these obligation increase demand for tax. These taxes cause the inflation to rise
Stop paying #inflation_control_fee, the deficit will turn into surplus


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