Interest rate hikes expose fragility of international banking system

LAHORE: Volatility in the international financial markets, following the collapse of Silicon Valley Bank in the United States and the rescue of Credit Suisse Bank by Switzerland’s UBS Group AG, etc, have surely hit the strong liquidity positions of the American and British banking systems.

The emerging scenario has thus forced the central banks of the two countries to increase their respective interest rates to support their economies, though it remains to be seen if lenders could handle the soaring borrowing costs amid all this turmoil. While the Saudi National Bank had admitted it had been hit with a loss of around 80 per cent on its investment in Credit Suisse, the collapse of Silicon Valley Bank (SVB) earlier this month has been linked partly to the US Federal Reserve’s recent rate moves.

A Western media outlet had commented: “The SVB had poured deposits into long-term securities whose value had fallen as interest rates rose. Those losses spooked depositors and led to a run on the bank.”

It is imperative to note that following the Silicon Valley Bank collapse, New York’s Signature Bank also experienced a similar disaster as apprehensive depositors had opted to pull out their funds.

Toeing in the footsteps of the US Federal Reserve, the Bank of England has also raised interest rates to 4.25 per cent after an unexpected jump in inflation and has warned of further pain. The London-based Financial Times has opined: “The rise, which was in line with economists’ forecasts, comes a day after data showed that the annual rate of inflation jumped from 10.1 per cent to 10.4 per cent in February (partly due to higher clothing and footwear prices). It is the 11th consecutive increase from the bank, which started raising rates in December 2021.”

Another British newspaper The Telegraph writes: “The Bank of England has raised interest rates for the 11th time in 18 months after data showed that inflation grew unexpectedly last month. The Consumer Prices Index came in at 10.4 pc, compared with predictions of 9.9 pc. The policymakers said the Bank was ready to act in the event inflation continues to climb.”

BBC News feels the jump in rates means that mortgage costs for some homeowners will rise and some savers could get better returns.

The state-run broadcaster states: “People on typical tracker mortgage deals will pay about £24 more a month following the latest increase and those on standard variable rate mortgages face a £15 jump. The high price of energy has been the main driver over the past year, with gas and oil prices surging in the aftermath of Russia’s invasion of Ukraine. Other factors such as worker shortages and food costs have also fueled price rises.”

On Wednesday last, the US Federal Reserve had raised interest rates a quarter-point amid the chaos that has engulfed the global banking system in recent weeks.

The Guardian reports: “Facing the worst banking crisis since 2008 and the highest inflation rate in a generation, the Federal Reserve chose to keep fighting price rises and announced another hike in interest rates. The US central bank announced that its benchmark interest rate would rise another quarter of a percentage point to a range of 4.75% to 5% – its ninth consecutive rate rise and the highest rate since 2007. A year ago interest rates were close to zero. The latest increase was smaller than the half-point increase that some had expected before a series of bank collapses shook global markets.” The “Fed chairman, Jerome Powell, said the Fed had considered pausing rates in the days running up to the decision but had concluded that the banking crisis was under control and that more rate rises were needed to bring down inflation.”

The Guardian quoted Powell, an American attorney and investment banker now heading the Federal Reserve as its 16th Chairman, as saying: “We are committed to restoring price stability and all of the evidence says that the public has confidence that we will do so. Although inflation has been moderating in recent months, the process of getting it back down to 2 per cent has a long way to go and is likely to be bumpy.” As far as the Eurozone is concerned, inflation here is averaging 8.5% and is likely to remain high for a long period.

Coming to the continuing economic meltdown in Pakistan, we all know that on March 2 this year, as Reuters reported, the country’s Central Bank had raised its key interest rate by 300 basis points, exceeding investor expectations. Remember, cash-strapped Pakistan was trying to fulfill yet another International Monetary Fund conditionality to get a loan tranche released. Reuters had maintained: “The key rate of the State Bank of Pakistan (SBP) now stands at 20%, its highest level since October 1996. Investors polled by Reuters had expected a rate hike of 200 bps. In its last policy meeting in January 2023, the bank raised the rate by 100 bps to 17%. It has now raised rates by a total of 1025 bps since January 2022.”

Just across the border, the Indian economy is seemingly in a far more comfortable position, poised at a low-risk low-reward position even if there is a global slowdown. The Hindustan Times has propounded: “One of the biggest fallouts of a global slowdown will be the impact on exports. In the 10-year period from 2000-01 to 2009-10, annual growth in exports (in dollar terms) was more than 20% in seven years. The 10-year period from 2012-13 to 2021-22 saw an export growth of more than 20% in only one year.”

Reuters adds: “India’s unemployment rate rose to 7.45% in February 2023 from 7.14% in the previous month, data from the Centre for Monitoring Indian Economy showed. The urban unemployment rate declined to 7.93% in February from 8.55% in the previous month, while the rural unemployment rate rose to 7.23% from 6.48%, the data showed.” The Chinese economy is rebounding since it began to initiate reforms in 1978. Its GDP growth has averaged over 9 percent a year, and more than 800 million people have been lifted from the poverty line. The February 2023 report of the International Monetary Fund has projected: “The economy will expand 5.2 percent this year versus 3 percent last year. Even so, China still faces significant economic challenges. The contraction in real estate remains a major headwind, and there is still some uncertainty around the evolution of the virus. With a shrinking labour force and diminishing returns to capital investment, growth in coming years will depend on boosting declining productivity growth. Without reforms, we currently estimate growth to fall below 4 percent over the next five years.”

CNBC has quoted a globally-acclaimed research form Messrs Wood Mackenzie as saying: “China will make up nearly 40% of the rise in global oil demand in 2023.” However, the World Bank has assessed the developing situation in these words: “Global growth is slowing sharply, with worldwide economic output projected to be just 1.7% in 2023. World Bank economists are warning that the downturn would be widespread and any adverse developments risk pushing the global economy into recession. Slowing growth affects 95% of advanced economies and nearly 70% of emerging markets and developing economies -- with the potential for increasing poverty rates in some regions.”

Revisiting the 2023 edition of the World Economic Forum Global Risks Report, which came in January this year, one finds that it had come out with a few correct prophecies. The report under review had predicted that governments and central banks could face stubborn inflationary pressures over the next two years, cost of living will dominate global risks in the next two years while climate action failure will dominate the next decade, technology will exacerbate inequalities while risks from cyber-security will remain a constant concern and food, fuel and cost crises will worsen the societal vulnerabilities.