The Problem: Economy!
In 2020, the single biggest challenge faced by PTI government in Pakistan is economy. The GDP growth rate is down to 2.5%, the tax collection targets are falling short, PSX stock exchange is still in the red since PTI got the government, the inflation is highest in South Asia at over 14% and in general, there is massive unrest in public due to economy.
What if this can be fixed in a manageable way, in relatively short time?
What if there is a fundamental mistake being made by policy makers which is stagnating the economy?
Why is there is no significant movement in market despite the tens of billions of dollars poured in CPEC and other mega projects?
The Key Reason
The answer to above questions can be summarized as follows:
There is no cash available to do business!
In other words: The federal interest rate is so high at 13.25%, that businesses are starved for cash and are dying left and right. Remember: cash is the oxygen for business. If I have to make a payment of Rs 1,000, but my business earned only Rs 500 - I cannot take a loan of Rs 500, meet my obligations and turn around business next month to return loan and keep on going. I’ll have to shut down the business if I cannot earn more than my expenses and I do not have any cushion.
However, if I have credit available on easy terms, I’ll leverage credit to stay afloat and grow my business.
In short:
No cash => No business => No jobs => Low GDP => Poor, hungry public => Everything seems expensive
Cash available => Businesses thrive => Jobs created => GDP growth => Thriving public => Things seem affordable
The Data: Kamyab Jawan Program
While we can look at case studies of USA, European and Japanese economies on how they have low inflation despite having super low interest rates - the single most important data point we have is the data from Kamyab Jawan Program.
The key point to note is that Kamyab Jawan program is offering loans at 6 to 8% interest rates - and over 1 million people applied for it! Compare it with the regular loans, and the demand for bank loans actually declined in 2019. Declining demand for loans is an early indicator of the economic slowdown!
Whereas, Kamyab Jawan Program has demonstrated the extreme desire in Pakistan market for affordable cash. Whereas, the same market is not willing to take loans at rates available from banks.
Instead of restricting the low interest rates to Kamyab Jawan Program only, why not just lower the rates for EVERYONE!
Managing Inflation for Essential Items
But, won’t lowering federal interest rates increase inflation? Not exactly. It is possible to have low inflation *caused* by low interest rates! The key point to understand is that the prices for essential goods can be controlled by matching the supply with demand. This way, the prices will remain in control regardless of interest rates.
Target interest rate
Okay, we agree on lowering interest rates from 13.25%, but what should be the target. My 2 cents will be to have a long term target to match US Federal Interest rate. USA Federal interest rate is 2% currently - and gradually lowering our interest rate to this level can be an ultimate target to go for. However, for intermediate term, the target can be set to 6% and achieved gradually in a time frame of 7 to 8 months (1% reduction per month).
To put things in perspective, Bangladesh’s rate is 6%, India is 5.15%, Japan is -0.1%, UK is 0.75% and Australia is also 0.75%.
Aiming for a super low interest rate like 2% in say, in 3 to 4 years time frame will put Pakistan economy in a growth mode like never before.
To get a historical perspective of impact of low interest rates, the key eras to review are:
To get a historical perspective of impact of low interest rates, the key eras to review are:
- 2002 to 2005, when the interest rates were in single digits, and GDP was growing at 6.6% annually.
- 2014 to 2016, when interest rates went as low as 5.75% and economy grew at 5.8%
An important point here is to stick with this decision consistently month over month for 6 months minimum, so that business community gets confidence in stable economy - and they invest with confidence.
Benefits
Here are the key benefits we can expect to reap from lowering interest rates:
1. Business Activity Spurred:
Affordable cash availability will help businesses as they will be able to leverage cash for growth and for surviving challenging times.
2. Job Creation:
More businesses will mean more jobs being created. Thus a key promise to create 10 million jobs will have a high likelihood of being fulfilled.
3. GDP Growth Compounding Effect
Growth in businesses and in job creation will directly result in GDP growth. A strong GDP growth will result in a compounding effect as growing economy attracts foreign investors and they will invest from fear of missing out (FOMO).
GDP growth => Foreign investment => Even more GDP Growth
4. Marginal Profit Business Creation!
An important issue with high interest rate is that any business with lower yield than interest rate will not be deemed feasible. Once the interest rates are lower, people will do businesses with marginal profit margins as well. This will not only help solve more public problems, but will create employment and economic growth.
5. Leverage using Fractional Reserve Banking
Currently, due to high interest rate, the fractional reserve banking cannot really work in Pakistan for any meaningful multiplier. However, once the interest rates are super low, we will see the leverage in action via fractional reserve banking.
If say we’re able to get 10x leverage by enforcing 10% of capital availability for banks - the net effect will be 10x growth in economy!
6. De-incentivized Money Stagnation
Low interest rates will de-incentivize putting money in National Savings, and will make people to deploy funds to work.
Currently, the flow of funds in Pakistan can be summarized in 2 key ways:
1. State Bank of Pakistan Prints Money -> Govt deploys funds -> Public gets money and puts in banks -> Banks put in National Savings -> Dead End!
Currently, the flow of funds in Pakistan can be summarized in 2 key ways:
1. State Bank of Pakistan Prints Money -> Govt deploys funds -> Public gets money and puts in banks -> Banks put in National Savings -> Dead End!
2. State Bank of Pakistan Prints Money -> SBP Loans to Banks -> Banks put in National Savings -> Dead End!
Low interest rates will force banks to loan funds to people instead of stagnating funds in National Savings. Thus circulating money in country instead of making it reach dead end!
The summary of discussion is that an important decision needs to be made to kick start the economy. And the decision is to lower federal interest rates into single digits down to 6%, and stick with the decision for at least 6 months to see its effect.
In a nutshell:
No cash => No business => No jobs => Low GDP => Poor public => Everything seems expensive
Cash available => Businesses thrive => Jobs created => GDP growth => Thriving public => Things seem affordable
Low interest rates will force banks to loan funds to people instead of stagnating funds in National Savings. Thus circulating money in country instead of making it reach dead end!
Summary
The summary of discussion is that an important decision needs to be made to kick start the economy. And the decision is to lower federal interest rates into single digits down to 6%, and stick with the decision for at least 6 months to see its effect.
In a nutshell:
No cash => No business => No jobs => Low GDP => Poor public => Everything seems expensive
Cash available => Businesses thrive => Jobs created => GDP growth => Thriving public => Things seem affordable
