Economic growth should be the ultimate objective of policymakers
along with redistribution of resources among the society to maintain the
balance among the distribution of resources. Following such a policy may reduce
the gap between rich and poor, hence lesser income inequality.
Nevertheless, talk of the town is not in general,
growth but inflation, exchange rate depreciation or forced appreciation, on
target and off target tax collections, piling or reducing public debt and these
days the most important loss of economy due to dharna and floods. No doubt these are as important as some other
indicators such as interest rate, private sector credit, debt servicing,
allocation of budget etc. There is a possibility that everyone is thinking
about “economic growth” but not explicitly. More importantly, most of us have
failed to form a logical link between the above mentioned variables and
economic growth.
I and some of my other colleagues and friends always follow
theoretical foundations while presenting an argument. Although not everything
can be explained by just theory, nonetheless, rigor always remains the core of the
debate. In general, during the debate, just to win an argument, someone from
the group would stand call other’s argument non-pragmatic. The above argument
is important to mention here because when policymakers try to set different
indicators in finding the pragmatic versions of debate/story they may divert
from the actual target, which is growth. On the other hand while following
“just growth” they may follow growth as well as welfare of the society. In my
opinion following “just growth” is the pragmatic approach not the other way
around.
Going back to traditional growth models investment is
core of the economic growth. Investment can be done by utilizing saving or
borrowing from the Banks. In Econ 101 we learn that investment is a function of
interest rate. Although interest rate is insensitive to investment in the short
run but it is not totally redundant. Studies suggest that interest rate
investment nexus in the long run is significant therefore, we cannot ridicule
it. Moreover, investors have been continuously asking to decrease interest rate
since the new government took over the office last year.
Interest rate is the cost or price of borrowing.
Nominal price is different than real price of borrowing. When we talk about
nominal interest rate then it is nominal price of borrowing while real interest
rate is the real price of borrowing. To contain the inflation the State Bank of
Pakistan is not decreasing the interest rate. Although inflation is dropped to
7 percent nonetheless fear of higher inflation expectations is preventing the
SBP from decreasing the discount rate.
It is evident from the picture that real interest rate
is positive which implies real price of borrowing is quite high. Should it be
closer to zero or negative?
Positive real interest rate is certainly not good for
the investors because no one wants to borrow and high real price. This is one
of the reasons private sector credit creation is not picking up along with
several constraints and hurdles faced by the investors, which shrinks the
profitability of the ventures.
Question is why are they not decreasing the discount
rate? Is it only due to higher inflation expectations? These policies are
similar to “sado monetarism”, a term coined by the Nobel laureate Paul Krugman.
It is just spoiling the ultimate goal, i.e. growth.
According to the Asian Development Bank, IMF and World
Bank Pakistan’s economy is recovering which implies that recessionary trends
are going away. Inflation has come down. Exchange rate is at the unreasonable
level after forced appreciation. Due to improvement in energy situation, though
slightly, and better energy management investors want to invest. Therefore,
there is no point in keeping the discount rate at higher level, which is also
keeping the real rate higher.
Besides above, we are out of acute stagflation
therefore, it is not good to follow conservative central banker’s policies.
Since most of the SBP’s policies are governed or in-line with the Ministry of
Finance therefore the SBP with the agreement of the MOF should decrease the
interest rate so that real interest rate declines and come closer to zero if
not negative. This would kick off the investment in various sectors including
the services sector which is the most resilient sector, especially during the
energy crisis since 2008.
Since rules of the game are not clearly spelled out
thus it is also possible that the monetary policy does not follow pragmatic
approach instead follows the instinct of the BOSS. If it is true then we should
stay away from visceral
type monetary policy and move towards objective oriented monetary policy.
Rules of the game are very important before managing any
policy. If Central Bank’s task is to control inflation at the socially optimal
or minimum possible level or growth enhancing level or monetary stability then it
should be followed strictly. Nevertheless, the SBP needs complete operational
independence to perform better. If they continue to listen to the Ministry of
Finance then it is will be visceral Darnomics. No one knows what is it and what
it will be. I hope they formulate the policies pragmatically instead of
obduracy.
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