On Tuesday, October 10, 2011 the State Bank of Pakistan announced its new monetary policy in which the central bank decided to cut its benchmark discount rate from 13.5% to 12% ( or 150 basis points)

The decision, which was revealed in a press release by current acting governor Yaseen Anwar, has come out as a shock to most experts on the subject. Most connoisseurs anticipated a cut, of about 50 to 100 basis points, but not to the extent made by SBP.

The purpose of cutting down the interest rates (or discount rate) is to lower the borrowing costs and encouraging people to invest.

SBP verdicts have drawn mixed reactions from market analysts. Some analyst believes that cutting down the interest rate will have amicable effect on the investment while others beg to differ and say that it will cause high inflation in an economy that is already going through a phase of depression.

Securities firm Arif Habib Ltd said in a note, “In our opinion, recent cuts in the policy rate point towards SBP short sightedness. We think it would be counterproductive to allow the rates to ease that soon, allowing money supply to increase and feed sustained higher core inflation.”

Salem Ali, an economist at Standard Chartered Bank said, “We haven’t made up our minds whether or not it (inflation) is sustainable or not. We do a see risk of inflation in 2012 with a probability of a rate hike as early as the second quarter of 2012 (April-June quarter).”

Muzammil Aslam, an economist at JS Global Capital, termed the rise as a gamble and said, “At the same time this is a gamble. Pakistan has said no to the International Monetary Fund and we have a large fiscal deficit before us. We need to see whether this cut helps stimulate the economy.”

Aslam is wary of the fact that in the current business cycle of Pakistan the cut in rate would not arouse any investment activity. The Economist was however assured that the economic malaise in Pakistan such as the power crisis would remain unchanged despite these valiant moves.

This is the second time Yaseen Anwar has cut down the interest rates during his tenure since taking over the role of governor from Shahid Kardar. Former governor was against the cut down and resisted changes in interest rates as he deemed it to be a dangerous fiscal extravagance.

In Yaseen’s tenure the interest rates have declined by 2% (from their original position of 14%). The governor of SBP said that this is due to drop in inflation which was noted to be 10.2% during the month of September.

Inflation in Pakistan for fiscal year ending in June 30, 2011 was clocked at 13.3 percent. SBP is aiming to maintain it below 12 percent for the fiscal year ending June 30, 2012.

The discount rate is the rate at which commercial banks borrow money from the central bank.

A lower interest rate means commercial banks can lend money to their customers at a lower rate thus encouraging them to borrow more money.