Will the private sector borrowing from banks slow down in the wake of the interest rate tightening?CENTRAL banks often love to > surprise markets. But they do it with a clear purpose.

If a central bank makes a move in line with the market anticipation, this means the market has already somewhat factored it in and started behaving accordingly. That can weaken the effectiveness of that particular move.

This explains the recent hike in the policy rate by the State Bank of Pakistan (SBP).

That said, an increase of 25 basis points in the SBP policy rate, following a long-overdue downward adjustment in the effective exchange rate band, is a step in the right direction.

On Jan 26, the central bank raised the rate to six per cent after keeping it unchanged since May 2016 at 5.75pc.

Inflation as a by-product of higher economic growth is good for an economy. But monetary economists keep researching to find out the .

level beyond which it starts hurting economic growth sentiment.

According to an SBP study, headline inflation of about 6pc tends to hurt our economic growth sentiments.

So, one big issue that the policy rate hike has tried to address is to pre-empt the rise of inflation to that level. And all would agree that apprehensions for inflation to reach that level are not unfounded, particularly after a rise of up to 10pc in prices of petroleum products since Feb 1.

But a question remains: is a modest 0.25-percentage-point increase in the policy rate enough to contain money supply, especially reserve money growth, in order to mitigate inflationary pressures? Central bankers are confident. `The efficacy of the transmission of monetary policy signals has become stronger in recent years (beginning from August 2009 when the SBP introduced the concept of an interest-rate corridor and kept supplementing and improving it since then),` says a senior central banker.

`With a more efficient mechanism available for monetary policy transmission, you can steer money supply in the desired direction even with a modest increase in the policy rate,` he said.

Pakistan`s economy is set to grow around 6pc during this fiscal year. So, demand-induced inflationary pressure makes sense for the central bank.

Besides, rising global oil prices can also understandably continue to add to this pressure.

Missing the economic growth target is not an option, keeping in view that joblessness is high and the country remains heavily indebted. Moreover, letting inflation rise beyond 6pc won`t be good. So, reversing a long-stretched lax monetary policy stance is a natural response to the emerging realities.Reserve money growth remained somewhat subdued (at around 2.4pc between July 1, 2017 and Jan 29, 2018 compared with 9pc in the comparable period of the last year). That partly explains why the SBP didn`t opt for tightening the monetary policy earlier during this fiscal year.

Factors affecting growth of reserve money (both net domestic and net foreign assets) may see an expansion in the second half of this fiscal year, according to former central bankers. This is one reason why a rate hike in the beginning of the second half makes sense.

After the increase, fresh government borrowing from the banking system should become costlier. This may help check an overshoot in such borrowing, which shows an upward trend ahead of general election.

Can the private sector borrowing from banks slow down in the wake of the interest rate tightening? `Given the growth momentum in industrial production and given the fact that CPEG-related projects may expectedly continue to provide further growth impetus, it is very unlikely,` says the head of corporate credit of a local bank.

There are two other factors that can keep growth of private sectorcredit flows not as robust as in the last fiscal year. First, companies are doing well and their higher earnings in the past two fiscal years have reduced their needs for bank borrowing.

Secondly, expansion projects in energy, food and textile sector of the last two years have completed or are near completion. That along with an expected moderation in high demand for consumer credit in the last two years can now affect the pace of lending to the private sector as a whole, some bankers say.

A slowdown in the private sector credit off-take is evident from the fact that gross lending of banks to private sector businesses fell to Rs253bn in July-December from Rs322bn a year ago, SBP stats reveal.

How the policy rate hike can affect banks` rates of return to depositors? Well, it should ideally create room for them to improve depositors return as yields on treasury bills and bonds rise and as they begin to re-price loans.

Interestingly, banks had started increasing interest rates on loans even before the policy rate hike, but since they were doing this modestly, targeting certain sectors and through repackaging loans, it wentalmost unnoticed, bankers say.

They were doing this to boost sagging profits, as a stable monetary policy in place since May 2016 had brought banking spreads to low levels.

Is the recent increase in policy rate followed by a rupee depreciation that began in December enough to help the SBP achieve twin objectives of monetary policymaking, ie `securing monetary stability and fuller utilisation of thecountry`s productive resources`? Some analysts answer in the negative.

`Given wider twin deficits, lower forex reserves, higher inflation and the coming impetus to price pressures from needed increases in fuel prices (weaker rupee, higher international oil prices), the SBP needs to do more on both interest and exchange rates,` says Raza A.

Agha, a London-based Pakistani economist, currently the executivedirector VTB Capital.

`Cautious and proactive macromanagement are also critical because without the decline in SBP forex reserves (and underlying loose macro-policies) sustainably arrested, sovereign rating actions will follow while relations with the [US President Donald] Trump administration could mean traditional donors require more stringent policy action in return for support.`•