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High oil prices threaten Pakistan rate cuts

By Ovais Subhani

KARACHI: Pakistan's plans to further cut interest rates to boost investment and lower domestic debt servicing costs could be threatened by rising world oil prices, bankers and analysts said on Wednesday.

The government cut interest rates by two percentage points early in January, spurring a nearly 30 percent jump in the Karachi Stock Exchange this year and fuelling hopes that further cuts would help shore up Pakistan's faltering economy.

"The inflation cycle is now back on its way up...there may not be an immediate threat but if oil prices continue to remain high the scope for further cuts in interest rates would be limited," Saqib Sherani, an economist at ABN AMRO Bank, told Reuters.

Oil prices have climbed above $30 a barrel, their highest since January 1991 when Iraq invaded Kuwait.

Sherani said a decision by the government -- which sets domestic fuel prices -- to boost prices in December when world prices hit $24 a barrel had already started to stoke inflation.

The Federal Bureau of Statistics said on Monday the consumer price index rose 0.2 percent in January from December, and was up 3.43 percent from January 1999.

"If international oil prices continue to remain above $28, inflation is likely to be in the range of 4.5 percent to five percent by the end of the fiscal year (in June)," Sherani said.

GOVT COULD BE STYMIED ON RATE PLAN

Bankers in Karachi said higher inflation rates could put a halt to government plans to push commercial banks' prime lending rates down to 12 percent, from the current 14 to 16 percent, which are already down from close to 20 percent a year ago.

The treasury head at one foreign bank said signals from the central bank suggested the plan was to push the six-month government treasury bill yield down to around 6.5 percent a year in the next couple of months, from a cut-off yield of 7.9869 percent in an auction last week.

The yield in January 1999 was slightly more than 12 percent a year.

The rate cuts have reduced the government's cost of servicing its large domestic debt, but bankers said there had been no corresponding move yet on the investment side.

The central bank in its latest report on the economy said private-sector credit in the first six months of the fiscal year grew by 28.7 billion rupees, against a full-year target of 104.5 billion rupees.

Bankers said a drive to recover over 145 billion rupees in bad debts, launched by the military government when it took power last October, had dampened credit growth.

They said business executives halted their investment and expansion plans and diverted funds to settle their old loans.

"Apart from the recovery drive, the uncertainty after the coup has also kept a number of businesses away from fresh investment," one senior banker said.

He said government plans to introduce a general sales tax at the retail level, a long-standing demand of the International Monetary Fund, from July would also fuel inflationary pressure.

"The government's drive to lower interest rates was helped by low inflation. If inflation starts surging before a real economic recovery sets in they will have to rethink the whole strategy," the banker said.-Reuters