Interest Rate is Not a Substitute of Tax

State Bank of Pakistan raised its interest rate to its highest level 13.5% to cope with the inflation. This step by SBP would not be able to control the real problem of Pakistan’s economy but to create more complexities for economic progress. This rise in an interest rate could not be a substitute of low tax collection.

When we look at the different interest rate of regional countries, which are in China 5.31%, India 4.75%, Taiwan 1.25%, Korea 2%, Japan 0.1% and Turkey 6.5%, we come to know that Pakistan is completely discouraging the foreign investment. Investors would switch their business into these labour-intensive countries.

Inflation cannot only be the reason of the massive money supply in the country, there are also many factors causing the high inflation rate. In case of current economic scenario, Pakistan is having cost push inflation, b unfortunately, our government is not paying attention on the real cause of our depressed economy. Purchasing power of people of Pakistan has devastated the business abruptly. Every business in Pakistan is showing negative balance. Companies are downsizing and trying their best to cut the operational cost. This increase in the interest rate would be like the last nail into the coffin for businesses in Pakistan. Pakistan’s economy need business, foreign investment so that it may decrease the unemployment rate and increase the purchasing power of the people in the same way. Business in Pakistan has already been spoiled and how more dwindle on SBP wants? Our industrial contribution in GDP  in FY09 dropped to -0.92% from 0.24. In the hard time policy, makers should be pragmatically looked over the situation and decide.

According to the CIA world fact book 2010 report, Pakistan has $2,600 per capita income approximately 18,500 per month. How much more a person can save? You cannot overlook micro economics in formulating policies for macro economics.

In this critical situation, the continuous devaluation of Rupees, decreasing flow of investment and business, increasing tariff of energy sources, increasing production cost and rising number of unemployment are main causes for inflation. This kind of inflation has drowned the purchasing power of people very much and this high interest rate never ever increases the saving rate. For the poor people of Pakistan, this act is not more than but adding fuel to the fire. Because, poverty rate is more than 40% and unemployment rate has swelled up to 15.2%.

If we take a look back at four years in foreign investment in Pakistan, which were in FY07 $1,820.4 million, in FY08 $44.3 million, in FY09 decreased to – $510.4 million and in FY10 this increased to $587.9 million, which is not very encouraging. However, by incrementing 1% more in an interest rate would devastate foreign investment in the next year.

High inflation rate also would be havoc for our currency rate. When an interest rate is high, currency of any country would devaluate in the foreign exchange market, Because when investors slash down their investment or closed down their businesses in the country and go away, the demand of money in the foreign market would cut down. Because of this, within two years, Pak rupee dropped its value up to 40% against US dollars. Pakistan has total $52 billion foreign debt, and this devaluation will increase total debt services. The frequent depreciation of this exchange rate in two years added Rs.1125. Billion to public debt services. This devaluation would dwell the economy into the trash.

Now, Pakistan is going through in a very typical situation. Our economy needs proper reforms of the most important two balancing tools of economics that  is monetary and fiscal policy. Economy needs both of them, because one tool cannot be a substitute of the other. If one of these two could not be properly planned or worked the country’s economy would not be survived. Both are the balancer for an economy. Government should use the fiscal policy, as well, to stabilize this country. Monetary policy cannot compensate for the fiscal policy.

Tax is the main tool for this government in getting revenues for the economy. Pakistan has very low tax GDP ratio, which is only 10%. Inequality has been swelled very much. It is to be needed to impose taxes on high-income people, imports, especially luxury items by the government. So that, the burden of taxes would not affect poor people and the meanwhile it helps to decrease the difference between these two modes of classes. So, rather than increasing interest rate, government should reform fiscal policy and increase taxes.

Moreover, Government has to cut their unproductive expenses, luxury imports and foreign saving accounts by investing money in domestic accounts. Government should do their expenditures on infrastructure so that it may attract foreign investments for business, and this step will also be encouraged by local businesses as well.

Government has failed to manage government’s institutes, and it is continuously injecting country’s precious money in saving this drowned Institute. In this dilemma, government should do something for privatising these institutes because there is no other way to save these institutes. Revenues which collected from the taxes, should spend on paying back country’s domestic and foreign debt, which is about 58% of our total GDP, according to Debt Policy Statement 2009-2010. So, it is very important to pay back these debts first and focuses on self-development.  Our country needs to be out from this marsh as soon as possible and make our own way to progress.

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