Investment decisions of Pakistan’s private sector, led by a few large family-owned groups, are influenced by a myriad of factors. While interest rates may be a factor to consider, historical evidence suggests that interest rates are not necessarily the key determinant shaping the country’s investment trajectory.
All other factors are excluded here to better understand the relationship between interest rates and investments. Over the past five years, interest rates have more than doubled since May 2019, when they were 10.7%, and tripled since June 2020, rising from 7% to the current 22%.
Surprisingly, despite this significant increase, investment as a percentage of GDP has not crashed, dropping by just 2.4% from 15.7% in May 2019 to 13.3% now, according to official data. only.
In a country of 240 million people, beset by successive crises and facing the imminent threat of public discontent erupting into the streets, the issue is sufficiently relevant to warrant a systematic research effort. I have. Such efforts could be aimed at informing evidence-based policy interventions aimed at stimulating investment and unlocking a country’s economic potential.
Even though interest rates rose significantly to 22%, investment as a percentage of GDP fell by only 2.4%, highlighting the strange relationship between the two factors.
At first glance, the global investment environment (adversely affected by the pandemic during the period under review), political instability, unstable economic policies, prioritization of resource mobilization over investment needs, excessive government intervention in business; Factors such as security concerns are all overshadowed. There is a shadow on investment psychology.
In addition to the well-known factors mentioned above that are often emphasized by business organizations, the interesting relationship between interest rates and investment in Pakistan highlights certain unique aspects of the country’s reality. It is difficult to deny the possibility that a large amount of unused funds circulating within the Pakistani economy is flowing into Pakistan’s investor class.
Many top businessmen confess in private conversations that they keep multiple accounting books, making it clear that the activities recorded represent only a fraction of the actual size of their businesses. They justify this practice by citing examples of misguided and wasteful public spending, and argue that hidden wealth is effectively and efficiently utilized for private activities.
Another important factor that emerged during the background investigation was related to faith. Some wealthy oligarchs have revealed that they avoid the banking system due to religious beliefs that forbid interest (Riva).
In response to requests for comment on the anomaly under discussion, some prominent business tycoons and corporate executives defended their ranks while insisting that the State Bank adjust interest rates downward.
Lucky Group CEO Muhammad Ali Taba declined to comment on the issues raised, instead expressing cautious optimism. “It all depends on investment policy. I am confident that if energy prices are competitive and investment friendly, investment will start flowing again,” he said.
Gohar Eijaz, a prominent channel owner, real estate developer, leader of All Pakistan Textile Mills Association and former caretaker federal minister of commerce, production and home affairs, shared detailed responses on the sidelines of the discussion. He pointed out that historically high inflation rates have forced the SBP to maintain high policy rates.
He said, “The government is Pakistan’s largest bank borrower, with more than 70% of public savings invested in government bonds, while less than 20% is borrowed by the private sector, primarily for working capital.” emphasized.
“Countries where high interest rates are used to manage cost-push inflation often result in large fiscal deficits and reduced private sector productivity. However, with monetary stability and improved macroeconomic conditions, The situation is improving, with zero current account deficit, a 10% increase in exports, and a 38% currency devaluation over the past two years, with inflation now falling.
“Increased market demand has accelerated production. To reduce interest rates, the first focus should be on restoring growth by optimizing existing production capacity and encouraging new investment.” .”
Nasim Beg, CEO of Arif Habib Consultants and an experienced executive on multiple corporate boards, said:When interest rates were in single digits, many companies invested in capital equipment. [capex] Using a combination of debt and equity [typically a 70:30 debt-to-equity ratio]. Therefore, borrowing was considered beneficial to the company if the interest rate was around 10%.
“High interest rates have several negative effects, such as severely impacting companies that borrow long-term funds for capital investments.Long-term borrowings have variable interest rates, which impairs the feasibility of incurred costs. High working capital borrowings increase costly inventories, while high interest rates divert investable funds from equity investments to debt instruments.
“Furthermore, employment to support growth has stagnated, leading to higher unemployment and lower per capita purchasing power, further exacerbating the vicious cycle. The opposite effect occurs, lowering the P/E ratio. This forces companies to sell their stocks cheaply to attract growth capital, exacerbating the negative cycle. Finally, leveraged buyers in the stock market are forced to sell their stocks cheaply to attract growth capital. They shy away from using leverage in interest rates, which slows down market activity.”
Published in The Business and Finance Weekly Dawn on May 13, 2024
