Whether you leased a car last year or plan to finance one through a bank now, paying installments of your auto loans has become 50% cheaper compared to what it was last year. This is because the central bank reduced on Thursday its benchmark interest rate by another 1%, it is the fifth cut since March 17.
The State Bank of Pakistan’s monetary policy rate affects every interest rate in the market. Since the SBP has reduced this rate, commercial banks will also drop their interest rates.
To put it differently, when the monetary policy rate peaked to 13.25% in July 2019, the interbank rates (called KIBOR or K) were close to 14% and commercial banks were charging you K plus 4% to 7% or even more. It took the overall cost of your interest payment to anywhere between 18% and 21%. These rates remain fixed for one year.
The SBP has brought its rate down to 7% and KIBOR has moved accordingly to 7.9%. This means your next year’s installment schedule or the first year payment schedule (in case of a new car) will see nearly 50% reduction in the interest amount.
The latest rate cut by the SBP comes unannounced and its objective is to stimulate the economic growth. Lowering interest rates makes borrowing cheaper for individuals, businesses and the government who borrow more and spend more. This will boost economic activity and create more jobs.
The decision has been taken because the inflation outlook has improved. “The financial year 2020-21 budget is also expected to be neutral for inflation as the freeze on government salaries, absence of new taxes, and lower cost of making goods from reduced import duties should offset the decline in subsidies in some sectors,” the central bank said.
However, the economy has slowed down and risks to growth have increased due to the spread of coronavirus, besides fears of a second wave. The path of recovery remains uncertain due to which the central bank has shifted its priority towards supporting growth and employment.
The SBP’s monetary policy rate is revised every two months, but the latest cut comes within 45 days since the last announcement. The SBP has made an early decision keeping in view the re-pricing of loans worth Rs3.3 trillion due in early July. The Monetary Policy Committee felt that this is an appropriate time to take action as the benefits of interest rate reductions in form of lower costs on loans would be passed on to households and businesses who are paying back their loans. The reduction in rates will reduce their repayment cost.
The SBP says they aim to support households and businesses through the prevailing crisis and reduce the damage to the economy. With the current reduction, the real rates on a forward-looking basis (the policy rate less expected inflation) would be kept close to zero, which is appropriate under the current circumstances, it says.
Controlling inflation and ensuring economic stability are two of the SBP’s core functions. The central bank uses the interest rate as its tool to either boost economic growth or control inflation. Interest rates are lowered to boost economic growth and the opposite happens if it has to control inflation. However, inflation has slowed in the last couple of months, creating more room for the central bank to reduce interest rates.
Consumer Price Index (CPI) – an index to measure increase in prices of goods and services – for the financial year 2021 is expected to fall to 7% to 9%. Another reason for this decision is the World Economic Outlook (WEO) report. The WEO is an IMF report that gives analysis and forecasts economic developments and policies in its member countries. So, the MPC noted in the WEO released yesterday that the IMF has lowered 2020 global growth forecast further to -4.9%, which is 1.9% lower than in April, and projected a slower recovery than previously anticipated. They also revised Pakistan’s growth forecast to 1%, less than half of Pakistan’s budget estimate of 2.1%.
However, the MPC views for the external sector remain stable as the SBP has received around $725 million from World Bank, $500 million from Asian Development Bank, and another $500 million is expected shortly from the Asian Infrastructure Investment Bank.
The SBP started reducing interest rate since March 2019 when it was at a nine-year high of 13.25%.