ISLAMABAD: The State Bank of Pakistan laid the foundation for implementing growth-oriented economic policies and cut its key interest rate to a 42-year record low of 7%.
Given the macroeconomic conditions, the SBP Board of Directors reduced the policy rate by 100 basis points (1%) to 7%, which is the lowest rate in last 42 years, Governor SBP Ashraf Mahmood Wathra announced on Saturday after a board meeting. The new rates will be effective from May 25.
Since November 2014, it is the fourth cut in the key discount rate – a rate at which the commercial banks borrow from the central bank.
Initially, the central bank had cautioned against reducing inflation rates.
The SBP has lowered its key interest rate at a time when the federal government has decided to implement growth-oriented economic policies from the new fiscal year, beginning from July.
The industrialists have long been demanding the central bank to set the interest rate below 8% aimed at reducing their cost of business.
Finance Minister Ishaq Dar has already announced his government’s plan to introduce growth-oriented economic policies in the new budget, which will be unveiled on June 5.
The reduction in the policy rate will promote business activities in the country and reduce the input cost, Wathra said. However, he said there were other factors like availability and prices of gas and electricity that also affect industrial growth.
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Despite significant reduction in interest rates, so far the monetary policy is not working its way through the economy, as the government remains the single largest borrower due to steep decline in tax revenues, according to the independent experts. This has left very little credit for the private sector to borrow.
Further, Wathra said that after previous reductions in policy rates, two important developments took place.
“There was significant growth in long-term loans and trade financing quantum also jumped,” he said.
“Working capital requirements reduced due to steep decline in commodity prices,” he added
The board also reviewed the interest rate corridor –the band of minimum and maximum interbank rates, cutting the upper ceiling by 1% to 7% and fixing lower cap at 5% by bringing it down from 5.5%.
Wathra said the board decided to reduce the width of the corridor from 2.5% to 2% aimed at ensuring predictability in the money market.
The SBP governor also announced a new target rate, setting it at 0.5% lower than the key discount rate.
Although the key interest rate is 7%, the SBP will target the 6.5% rate and will ensure that the repo rate remains close to the target rate, the governor said.
Wathra said these changes were consistent with the SBP plan announced in February and in line with best international practices.
It is a good development and eventually the target rate will become the policy rate, former Governor SBP Syed Salim Raza said.
Raza added the corridor’s ceiling above the target rate will have slight penal cost for banks, as the SBP wants banks to fully utilize the available liquidity in the market before coming to the central bank.
“SBP will have to have more active open market operations so that the market repo rate reflect the SBP attention of keeping market rate close to the policy rate. This is aimed at reducing volatility in the money market,” the former SBP governor added.