I have previously written about how a small group of financial elites manipulate policies for their own benefit, leaving the real economy stagnant.
I have previously written about how a small group of financial elites manipulate policies for their own benefit, leaving the real economy stagnant.
This follow-up delves into a critical aspect of that manipulation: the unjustified maintenance of high real interest rates despite single-digit inflation, driven by an unfounded fear of high imports and pressure on the local currency.
Despite inflation now being in single digits, the government continues to maintain prohibitively high real interest rates. Why? The commonly cited concern is that lowering interest rates will trigger a surge in imports, thereby straining the local currency. However, this fear is misplaced. Businesses will not engage in meaningful economic activity unless interest rates align with the rental yield, which is no higher than 5.0 per cent in Pakistan. As long as KIBOR remains above 5.0 per cent, there is no significant risk of an import surge.
The misleading narrative of inflation and interest rates: A deeper issue lies in the misleading narrative pushed by research heads of major business publications, many of whom operate under the influence of economic elites, particularly banks.
These elites propagate high interest rates by framing inflation as demand-pull, implying that it is driven by excessive consumer demand. But Pakistan’s inflation is primarily cost-push, caused by external factors such as supply chain disruptions and rising production costs, not domestic demand.
Pakistan’s current tax target is approximately Rs13 trillion, with an astonishing Rs8 trillion to Rs9 trillion going directly toward repaying interest payments. If interest rates were reduced to 10 per cent, the burden of these repayments could potentially be cut in half. Lowering interest rates would not only alleviate the government’s financial load but would also stimulate economic growth. Growth, in turn, would impact energy demand positively, likely lowering energy prices through enhanced efficiency and increased utilization.
For instance, in 2013, the energy demand was 13,000MW, and as of 2023, this demand has remained stagnant at 13,000MW. The primary reason for this flat demand is the lack of growth, underscoring that interest rates must decrease to stimulate economic activity and, consequently, drive up energy needs sustainably.
KIBOR, rental yield, and the path forward: For Pakistan’s economy to thrive, businesses must have access to capital at affordable rates. This means aligning KIBOR with the rental yield. When the cost of borrowing exceeds the returns from real estate, businesses have no incentive to take risks and invest in productive ventures. Instead, capital flows into safe havens like banks, which are often not truly Shariah-compliant despite being labeled as Islamic, further stagnating the economy.
Countries like Japan and members of the Eurozone have maintained low interest rates for years to stimulate investment in productive sectors. The trillion-dollar company in the US, Apple, originated when a venture capitalist walked into a garage and invested in an adopted young man -- Steve Jobs. It is because of that investment that you’re reading this article on a device that came from that very technology.
In contrast, Pakistan remains trapped in a cycle of high interest rates that benefit a select few, stifling growth and limiting opportunities for small and medium-sized enterprises (SMEs) and other industries. Even the late Ratan Tata, a renowned figure in India, followed the true spirit of the Islamic economic system toward the end of his career, investing heavily in 40 innovative startups that led to wealth creation and employment. On this side of the border, however, even established businesses are shutting down as money is being doubled by parking it in banks (or so-called 'Islamic' investments) for four years.
Furthermore, to stimulate exports in the long run, interest rates need to be lowered as well. The government may worry that reducing interest rates could lead to an import surge, but there are alternative measures to manage such concerns. Recent initiatives, like the crackdown on money changers and curbing smuggling activities (in Pakistani terms, using ‘danda’), demonstrate effective ‘out-of-the-box’ approaches to control imports without resorting to artificially high interest rates.
Breaking free from elite-driven policies: Policymakers must recognise that maintaining high interest rates under the pretext of curbing inflation and controlling imports is a tactic used by the elite to protect their financial interests. What Pakistan truly needs is a drastic reduction in interest rates, even below 10 per cent, which would still provide a real interest rate of approximately 3.0 per cent.
This satisfies those who argue that interest rates should be at least 3.0 per cent above inflation (which is currently around 6.9 per cent), while ensuring that businesses can borrow, invest, and grow. Lowering rates to this level will not lead to excessive imports because the cost of capital will still exceed the rental yield.
The current policy framework, driven by elite-controlled business narratives, is choking Pakistan’s economy. The government must take bold action to lower interest rates, allowing the private sector to thrive and spurring the real economic growth that Pakistan desperately needs. Without this shift, the economy will remain captive to a small group of elites, while the rest of the nation bears the cost.
The government’s fear of high imports and currency pressure due to lower interest rates is unfounded. The real issue lies in KIBOR’s disconnection from the rental yield, which is stifling business growth. By breaking free from uninformed, elite-driven narratives and aligning interest rates with economic realities, Pakistan can unlock its true potential and foster sustainable, inclusive growth.
The writer is a graduate of LUMS and holds an MBA in consulting from the UK. He teaches financial markets in Pakistan and can be reached at: hissan3@gmail.com
