Pakistan's central bank, the State Bank of Pakistan, hiked its key policy rate by 300 basis points to a 27-year high. The 20 percent interest rate was the "highest in Asia". The decision was taken during the Monetary Policy Committee meeting which was preponed to March 2.

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The development came as the cash-strapped country scrambled to fulfil another demand by the International Monetary Fund (IMF) for the release of at least a $1 billion tranche from the $6.5 billion bailout to avoid an economic meltdown.

After the SBP rate hike, Dawn reported that Pakistan "completed all the prior actions needed for staff-level agreement (with the IMF)...to avert sovereign default". Meanwhile, Pakistan Foreign Minister Ishaq Dar said in a tweet on Thursday that the country is likely to strike the IMF agreement next week "as the negotiations are about to conclude".

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How do high-interest rates affect the country's economy and its people?

The historic interest hike will add to the woes of Pakistanis who are already struggling with skyrocketing inflation. Central banks increase interest rates to cool-off inflation. While it discourages consumer and business spending, most economists agree that high-interest rates also slow the country's economic growth.

High central bank interest rates will affect the cost of borrowing for banks. This makes loans expensive for both businesses and consumers — in a way that people will spend more on interest. This leads to higher borrowing costs, such as for buying a house. This eventually slows borrowing and hence, economic activity.

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Also, high interest rates mean more foreign investment. This, in turn, increases the value of the country's currency. The hike has been introduced when the Pakistani rupee was in a freefall mode and the foreign exchange reserves are running low.

The Pakistani rupee sank by PKR 18.98 on Thursday compared to the greenback and touched its historic low of 285.09 against one dollar by the end of the day. Currently, questions are being raised if the Pakistani rupee value will touch the 300-mark. Experts blamed the stalled IMF deal for the deteriorating economy, Geo TV reported.

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Meanwhile, the SBP forex reserves have been increasing "over time and are in a better place compared to four weeks back," the finance minister was quoted as saying. The data leased by the SBP on Thursday showed an increase of over $500 million in the net foreign reserves held by the central bank.

As on February 24, the foreign exchange reserves stood at $3.8 billion — seeing a hike of nearly $900 million over four weeks. Hailing this development, the minister said, "Foreign commercial banks have started extending facilities to Pakistan."

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Notably, the foreign exchange reserves increased after the SBP received $700 million as the government of Pakistan commercial loan disbursement from China in the week ending February 24.

This made Pakistan minister Dar hopeful who said "all economic indicators are slowly moving in the right direction".

Traders and industrialists expressed concerns over the SBP's recent hike. An industrialist was quoted by Pakistan media reports as saying: "The 20 percent interest rate was the highest in Asia...Nobody can survive with such high interest rates and record inflation."

'Inflation to rise further'

According to reports, consumer inflation in Pakistan is at 31.6 per cent, the highest level since data became available, i.e. July 1965. "The SBP said the average inflation for the year was now expected in the range of 27-29 per cent against the November 2022 projection of 21-23 percent," Dawn reported.

Meanwhile, the core inflation rose to 17.1 percent in urban and 21.5 percent in rural areas in February, the SBP said.

"The MPC noted that the recent fiscal adjustments and exchange rate depreciation have led to a significant deterioration in the near-term inflation outlook and a further upward drift in inflation expectations, as reflected in the latest wave of surveys," the SBP said in a statement.

First Published:Mar 3, 2023 12:16 PM IST