The State Bank of Pakistan has surprised the market by reducing the discount rate by 1.5% to 12%. This is the second rate cut in three months bringing the total reduction of discount rate by 2%. A number of analysts were expecting a reduction of 0.5% to 1% at the most. It may be noted that the earlier reduction of 0.5% in July was totally unexpected.
The rationale for the reduction is a decline in inflation and government borrowings.
This is a step in the right direction and will spur private sector credit as well as investment into businesses. It is important to note that interest rates and investments are inversely related. If interest rates go up, people choose to save the money trying to get higher interest rates while a reduction in rates forces people to reduce keeping money in interest earning areas and deploy their money in slightly riskier assets which give them a higher return.
In my opinion, interest rates should come down to 10% within this fiscal year, which is something not just prudent but also a necessity if the current government wants to win the next elections.