The State Bank of Pakistan raised interest rates by 150 basis points (bps) to 13.75% on Monday. This is an 11-year high and comes as Pakistan faces multiple economic struggles.
However, it increases your cost of doing business – directly or indirectly.
Suppose you have an outstanding loan of 1 million rupees. An increase of 150 basis points adds approximately Rs 1,250 to monthly installments on a loan of just Rs 1 million.
This is just the delta or change or increase in payment. Now, that number is by no means 100% accurate, but it gives you a rough idea of the type of interest burden that causes a 150 basis point increase.
The annual increase in payments on a Rs 1 million loan is Rs 15,000 and increases the total outstanding debt – disregarding the principal amount – from Rs 122,500 to Rs 137,500.
Similarly, on a loan worth Rs 5 million, the monthly interest payment increases by a substantial Rs 6,250. Annually it increases by a substantial Rs75,000.
SBP hikes policy rate by 150 basis points to 13.75%
Samiullah Tariq, head of research at Pak-Kuwait Investment Company, said it would significantly increase installment payments for people who took out bank loans.
“However, we can call this increase temporary because once the central bank lowers the policy rate after stability and improvement of the economy, this amount will decrease and installment payments could return to the same level that people paid before this increase,” he said .
In its statement, the central bank said the rate hike should help dampen demand to a more sustainable pace while inflation expectations remain anchored and risks to external stability are contained.
The MPC will continue to closely monitor developments affecting the medium-term outlook for inflation, financial stability and growth, it said.
Pundits react as SBP hikes interest rate
How a rate hike reduces demand
A rate hike increases the cost of doing business in the form of interest payments as cash is diverted to meet bank obligations.
In such a scenario, companies tend to divert resources to meet the higher obligations, thereby investing less than before. The same argument applies to consumers who spend less to make interest payments.
This lower spending/investment reduces aggregate demand and dampens inflation – at least in theory.