The State Bank of Pakistan increased the key interest rate on Thursday, March 02, 2023. The rate is higher than initially expected by investors, as the country seeks to encourage the International Monetary Fund to release the crucial $1 billion (USD) funding tranche. Let's learn more about the current interest rate in Pakistan and its effects on the economy and investments.

New Key Interest Rate in Pakistan

The State Bank of Pakistan (SBP) has set the new key policy interest rate at 20% or 300 basis points (bps), the highest level since October 1996. The current rate surpasses the expected rate hike of 200 bps. This increase in interest rate is one of the fundamental conditions put forward by the IMF. The new interest rate increase comes only a month after the last increment to 17% or 200 bps.

Factors that Led to the Hike in Interest Rate

Pakistan’s economic troubles started approximately 10 months ago. The regime change came at a crucial time when the country faced its worst economic challenges. Pakistan’s risk premium witnessed a significant increase of up to 100% post the regime change. One of the primary reasons for the rise in interest rates is to meet the IMF’s bailout conditions.

Besides the Pakistani Rupee free float, another requirement was to increase the interest rate to control inflation - which in the current scenario has increased to its highest level in 50 years. Currently, Pakistan’s CPI index stands at 31.55%. Unless the IMF staff-level agreement is reached, things appear gloomy for the economy.

Effects of the High-Interest Rate in Pakistan

While the interest rate in Pakistan is expected to rise further, let's look at some of the negative effects of the hike on businesses and individuals.

Higher Borrowing Costs

Borrowing becomes increasingly difficult due to the increased interest rate in Pakistan. A borrower is liable to make more repayments when the interest rate is high, making it difficult to afford debt settlement. It can discourage people from borrowing money to invest in businesses, education or homes, leading to an economic slowdown and reduced growth.

Limits Consumer Spending

When interest rates are high, the cost of borrowing money increases - this indicates that consumers have less money to spend on acquiring goods and services. This can result in decreased demand for products and services, and concurrently, businesses are forced to reduce their production. Limited consumer spending triggers an economic downfall with higher unemployment and expensive goods and services due to limited production and supply.

Limited Investment Opportunity

High-interest rates in Pakistan will further discourage businesses from borrowing money. As the cost of borrowing increases, it negatively affects startups seeking operational funds from banks.

Despite the current increase in policy rates, another hike might still be on the cards to appease the IMF for a staff-level agreement. The higher interest rate can also trigger individuals to save more money and investment them in the right stocks and mutual funds. However, this can be risky if you lack knowledge of how the market works.

Make sure you're financially literate to understand the Capital Market Fundamentals. Once you ace the market conditions, it will help you pick the right investment options leading towards a steady passive income in the long run.