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Pak Econ - Assignment 01

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4 views

Pak Econ - Assignment 01

Uploaded by

muhammadali.majid99
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Monetary Policy of Pakistan

By:
Yusra Mahmood 2011418
Ashhad Ur Rehman 2011202
Muhammad Ali Majid 1950152
Aizah Sultan

Introduction:
Monetary policy refers to the measures implemented by the State Bank of Pakistan (SBP) to
regulate the money supply, manage inflation, stabilise the exchange rate, and support economic
growth.

Objectives of Monetary Policy:


1.Controlling Inflation: Maintaining price stability to protect consumers and businesses.
2.Fostering Economic Growth: Encouraging industrial and agricultural development
through appropriate interest rates.
3.Stabilising the Exchange Rate: Managing the value of the Pakistani rupee against
foreign currencies.
4.Promoting Employment: Creating favourable conditions for job creation.

Tools Used by the SBP:


1.Policy Rate: Adjusting the interest rate at which commercial banks borrow from the
SBP to influence overall lending and borrowing in the economy.
2.Open Market Operations (OMO): Buying or selling government securities to regulate
liquidity.
3.Reserve Requirements: Mandating the minimum reserves banks must hold to control
credit expansion.

Why is Monetary Policy Vital?


Monetary policy is vital for addressing challenges such as inflation, currency depreciation, and
external deficits, ensuring economic stability and growth

In the country of Pakistan, interest rate changes in monetary policy are implemented by the
State Bank of Pakistan (SBP), which is the central bank of the country. The approach is
influenced by economic challenges like inflation, fiscal deficit, and currency volatility. Brief
Overview:
1. Role of the State Bank of Pakistan (SBP)
The SBP primarily uses the policy rate also called the SBP target rate to operate monetary
policy.
This determines the cost of borrowing and influences the cost and availability of liquidity,
inflation, and economic growth.

2. Working of Interest Rate Changes


Interest Rate Hike (Tightening Monetary Policy):
It is applied when there is high inflation or to stabilise the currency.
- SBP hikes the policy rate: this increases the cost of borrowing for banks, businesses as well as
consumers.
- This peaks down consumer spending and business investments, thus bringing down an
economy.
- Brings in foreign investment in debt items such as treasury bills to strengthen the Pakistani
rupee.

Interest Rate Hike (Tight Monetary Policy):


This is used during economic slowdowns to spur growth.
- SBP lowers the policy rate and reduces the cost of borrowing.
- Increases consumer expenditure, business enlargement, and employment generation.
- It tends to increase inflation and reduces the value of the currency, if not check and balance

3. Transmission Mechanism in Pakistan.

Bank Lending Rates:


Commercial banks adjust lending and deposit rates in response to the policy rate changes by
SBP and hence affect consumer and business borrowing. For example, loan rates for
residential or businesses will be more expensive.

Government Borrowing:
The government is one of the largest borrowers in Pakistan. High rates increase the cost of
servicing debt, hence impacting fiscal deficits.
Consumption and Investment of Firms: Higher interest rates discourage borrowing and
spending. While lower interest rates have the effect of stimulating investment, this effect can be
blunted by structural problems in Pakistan, such as energy shortages and low confidence of the
investors.

Interest Rate and Inflation:


Higher interest rates attract foreign capital into short-term investment into treasury bills
stabilising the rupee. Lower rates can weaken the rupee and increase inflation due to higher
import costs.
4. Current Challenges Specific to Pakistan

High Inflation:
Persistent inflation, driven by food, energy prices, and currency depreciation, often requires a
tight monetary policy.

Currency Volatility:
Interest rate changes are used to stabilise the rupee, for foreign exchange reserves are limited.

Debt Dynamics:
Pakistan's reliance on domestic as well as foreign borrowing makes interest rate management
critical in controlling fiscal deficits.

The Impact of a 2.5% Interest Rate Reduction on the Business


Economy:
A 2.5% reduction in interest rates can have profound impacts on the business economy,
influencing both short-term activity and long-term growth.

1. Encouragement of Business Investment

Lower interest rates reduce the cost of borrowing for businesses, making it cheaper to finance
expansion projects, purchase equipment, or fund research and development (R&D).

This leads to several outcomes:

Increased Capital Expenditure: With borrowing becoming more affordable, businesses are likely
to invest in productivity-enhancing technologies or facilities which in turn spur's economic
growth.

Start-Up Activity: New businesses find it easier to secure loans; this leads to a fostering of
innovation and entrepreneurship.

Competitiveness: Companies can invest in cost-reduction strategies, enhancing their ability to


compete in both local and international markets.
2. Boost to Consumer Spending

Interest rate reductions lower the cost of borrowing for consumers, translating into higher
disposable income and spending power.

Key effects include:

Credit-Driven Purchases: Lower interest rates on mortgages, auto loans, and credit cards
encourage consumers to buy durable goods and homes which in turn benefits businesses
across industries.

Consumer Confidence: As borrowing becomes easier, people are more likely to feel optimistic
about their financial situation, this reinforces spending habits.

3. Employment Growth

Increased business investment and consumer spending drive higher demand for goods and
services, which leads to:

Job Creation: Businesses expand operations, requiring additional labour, reducing


unemployment rates.

Higher Wages: A tight labour market can push wages upward, benefiting workers and
contributing further to economic activity.

4. Impacts on Specific Sectors

Real Estate and Construction: Lower interest rates reduce mortgage costs, encouraging
home-buying and leading to a surge in construction activity.

Retail and Consumer Goods: Increased spending power fuels growth in retail and consumer
markets.

5. Risks and Challenges

While a 2.5% interest rate reduction has clear advantages, it is not without risks:

Inflationary Pressures: Increased spending and borrowing can lead to overheating in the
economy, causing inflation to rise.
Debt Accumulation: Lower borrowing costs may encourage excessive leverage among
businesses and consumers, raising concerns about long-term financial stability.

Inequality: Wealthier individuals and large corporations might benefit disproportionately,


exacerbating income and wealth disparities.

Conclusion
A 2.5% interest rate reduction can significantly stimulate the business economy, driving
investment, consumer spending, and employment growth. However, policymakers must
carefully monitor potential risks like inflation and debt accumulation to ensure that the benefits of
such a policy are sustainable. In essence, while the measure serves as a powerful catalyst for
economic activity, it requires complementary fiscal strategies to address its broader implications
effectively.

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