It has to be seen whether the PPP-led government, very fond of raising the slogan of change, will stand by the State Bank to make overdue corrections in the financial sector or oblige the rich investors
Speaking upon the condition of anonymity, many economists at international institutions have expressed grave fears of a huge currency crisis in Pakistan. In their view, the incoming crisis may match those seen in Mexico and some Asian countries.
Recent steps taken by the State Bank of Pakistan may prove to be too little, too late. Nonetheless, it has to be seen if the PPP-led government will stand by the State Bank or cave in under the pressure of protesting banks, and industrial and trading groups.
The State Bank of Pakistan’s expansionary monetary policy of the last several years has led to higher rates of inflation, a failing currency, and an ever-widening trade deficit. Furthermore, under relaxed regulations the banking sector has skimmed public savings transferring wealth from bottom to top. It is no wonder that such practices led to the numerous contradictions that can result in an unmanageable currency crisis.
To start with, interest rates in Pakistan have been kept artificially low. In recent times, interest rates were lower than the rate of inflation. This means that the borrowers, specifically the industrial and trading sectors, getting preferred rates, were using the money free of cost.
Naturally, this resulted in further expansion of money and devaluation of the currency. If the State Bank had continued with this policy, the Rupee would have gone into free-fall shortly.
The banking industry had the best of all worlds. Its spread — the difference between the rate it pays to the account holders and the rate at which it lends — was one of the highest in the world.
Banks have been paying very low rates to common savers and account holders. Their rates on savings accounts have been much below the rate of inflation and at the end of the day, account holders were left with less money than their principal amounts.
For example, if the bank pays 6 percent on Rs100, and the rate of inflation is 12 percent, at the end of the year the account holder’s principal amount will be trimmed to Rs94. It means that the account holders were paying from their pocket for maintaining savings and other accounts.
The State Bank had been expressing its concern over this phenomenon but took no action for a long time.
The common account holders have been bitten by currency devaluation as well. The value of their savings was and is being slashed by the falling Rupee: if the Rupee lost 10 percent in the last few months, the value or the purchasing power of common savers dwindled by the same percentage just because of currency devaluation.
Therefore, common savers are being skimmed from two ends by getting rates lower than those of inflation and by the falling currency value.
As a rule, someone’s loss is another one’s gain in the market. In this case, banks and big borrowers have been benefiting from such a skewed monetary and banking policy.
As stated earlier, banks were getting the highest spread and were lending to large borrowers at preferred rates. Incidentally, they have been charging exorbitant rates, sometimes exceeding 20 percent, from small borrowers. Borrowers in rural areas have been favourite victims.
Ironically, bankers and big borrowers in Pakistan’s financial markets keep their savings in foreign currencies at attractive rates. As apprehensions about the Pakistani economy intensify, they sell local currency to buy foreign money driving the value of the Rupee further down. Therefore, wealthy investors are the last ones to suffer due to the rising rate of inflation and falling currency.
As a matter of fact the prevailing situation suits the wealthy investors: they can borrow for almost nothing, keep their money in foreign currencies, and make lots of money through currency swaps.
This is the reason banks, traders and industrial groups are up in arms against the State Bank’s recent announced policies through which the central bank raised the interest rate to 12.5 percent and asked the banks to pay a minimum of 5 percent to account holders.
The State Bank has tried to create some balance in the financial market by making borrowing a bit more expensive. This move, though too little too late, was necessary according to many economists.
It has to be seen whether the PPP-led government, very fond of raising the slogan of change, will stand by the State Bank to make overdue corrections in the financial sector or oblige the rich investors.
Of course, the government is going to come under a lot of pressure due to the collapsing stock market. But it should analyse objectively whether the stock market is merely a bubble or actual reflects the growth rate of the economy. It seems that the stock market bubble was created through expansionary monetary policies which were unfair to the public and unsustainable in the long run.
Therefore, the government should bite the bullet of corrective monetary policy to save the financial system and avoid the imminent currency crisis. Rich investors are fixated on their undeserved profits at the expense of the health of the financial system. The government cannot or should not afford such an approach.
The writer can be reached at email@example.com
Source: Daily Times, 28/5/2008