Muneeb ur Rehman

The Pakistani government’s contractionary monetary policy has shown limited effectiveness to curb inflation, ultimately impacting the economy, reports WealthPK. Talking to WealthPK, Aliya Hashmi, a former member of the Monetary Policy Committee (MPC) of the State Bank of Pakistan, said the plan to reduce the money supply by increasing the policy rate does not reflect the ground reality.

“In contrast to many developed countries, individuals in Pakistan often exhibit limited responsiveness to changes in the policy rate. Raising the interest rate, instead of reducing the money supply through increased savings, ultimately acts as a deterrent to investment in the country," she said.

Source: State Bank of Pakistan

It is important to mention that Pakistan lags behind in terms of investment rate when compared with regional competitors. According to the World Bank data, the investment-to-GDP ratio hovers around 15%. In India and Bangladesh, the rates are 27% and 32% respectively. Aliya added that the interest rate was increased on the direction of the International Monetary Fund (IMF). The fact is that policy prescriptions need to be country-specific. Interest rate is effective in reducing inflation in developed countries like the USA and the UK. “Whenever the interest rate is increased to reduce consumer spending, it increases the public debt and repayment burden.

As a result, the government is provided with little fiscal space to finance public sector investment projects,” she said. “Decreased investment and reduced public spending jointly exert a negative influence on the already declining GDP. Coupled with the elevated inflation rates, which lead to a significant contraction in aggregate demand within the economy, limited public expenditure compounds the decrease in the GDP growth rate," she added. Aliya suggested that the government should focus on domestic productivity and address supply-side bottlenecks to curtail inflation. In a nutshell, the monetary policy directed at alleviating inflation has had multifaceted adverse effects on Pakistan's growth potential. A policy shift towards alternative approaches could yield more favorable outcomes.

Credit: INP-WealthPk