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Interest rate corridor and private sector financing: A way forward

Over the past five months, COVID-19 has restricted the business activities in the country. The government had imposed a lockdown to safeguard people from the coronavirus which eventually slowed down the business processes. It is important to note that the government has taken serious measures to prevent the coronavirus from spreading as well as to sustain the lives of people in the poor communities. Besides the preventive measures, the government has announced various relief packages to revive the business community. Among others, a substantial reduction in the discount rate is the one that provides considerable relief to the businesses to obtain funds and stimulate their operational networks.

Before the coronavirus, the discount rate was as high as 13.25 percent. In order to support and relieve businesses, the State Bank of Pakistan (SBP)on March18, 2020 reduced the discount rate by 75 basis points to 12.5 percent. However, there was pressure from the business community for further reduction in the policy rate. As a result, the SBP reduced the discount rate to 11 percent on March 25th.

The graph illustrates the position of the total credit to private sector financing and their growth over the last year. The diagram demonstrates roughly an increase of one billion rupees in financing flowing to the private sector in March (4.44%). This illustrates a positive and significant relationship between the policy rate and financing received by the private sector.

On April 17, 2020, the SBP further reduced the discount rate to 9 percent. The business community welcomed this initiative by borrowing more capital albeit at a decreasing rate. SBP further reduced the discount rate by 100 basis points on 18 May 2020 (policy rate = 8 percent). The continuous and substantial reduction in the discount rate led to a surge in private sector credit at a rate of 3.68 percent. This indicates a positive sign and an increase in financing for the revival of business activities. Finally, the SBP reviewed its monetary policy in June and further reduced the policy rate to 7 percent.

During the past four months, a decrease in the policy rate by 6.25 percent has increased the private sector financing by 11 percent. The benefits of a substantial reduction in the discount rate were not fully visible owing to the prevailing coronavirus pandemic. However, in the coming months,the activities could result in an increase in the use of creditas firms,especially those involved in sugar and cotton ginning,will pursue seasonal financing from September onwards.As a result of several incentives announced by the government,an emerging opportunity also exists for investment in the real estate business.

The government should create an enabling environment for the businesses and it can be achieved by a reduction in the cost of doing business. There should be proper checks and balances on input prices and stability in utility prices. The government should also provide tax incentives where required, encourage firms to invest in different businesses, and identify business opportunities. It is also necessary that the government should focus on Small and Medium Enterprise (SME) financing which enables small firms to borrow funds and start their businesses. The SBP may devise a policy to support different small-scale industries. This is the way forward which willnot only increase financing but also provide employment opportunities and contribute to the economy. As the effect of coronavirus seems to be dying out and businesses are opening up it is hoped that they will contribute towards the economy and utilize the financing at a cheaper rate.

MUHAMMAD ZUBAIR MUMTAZ, "Interest rate corridor and private sector financing: A way forward," Business Recorder. 2020-08-13.
Keywords: Economics , Economic issues , Economic values , Economic growth. Interest rate , Monetary policy , State Bank , Pakistan , SBP , SME , 2019

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