High interest rates, low investments

Sustainable technology and Industry 4.0-enabled technologies, most recently presented at the ITMA 2019 in Barcelona, Spain, are taking the global textile industry by storm. The tech world is rapidly moving forward and R&D in textile machinery continues to make remarkable leaps which, once availed, would prove to be instrumental for Pakistan, given the large share of exports associated with its textile sector. Yet somehow our textile machinery continues to be stagnant at the level of primary level equipment and outdated looms, coupled with the alarming decline in machinery imports.

To textile industrialists’ dismay, the crucial need for machinery upgradation remains unmet, and the fruitful benefits associated with recent technology sadly continue to be a remote prospect for the industry. The Pakistan Bureau of Statistics shows textile machinery imports to have fallen by around $60 million during the fiscal year 2019. The data below depicts a consecutive decline in textile machinery imports since April 2018, and this trend has spilled over into the current year with an 8% drop from the previous period. (Source: Business Recorder, 2019). 

It is clear that factors impacting the textile industry have a direct bearing on Pakistan’s economic health, turning textile machinery into an issue of national importance which requires urgent attention. Therefore, the urgent requirement of technological upgradation in the textile industry cannot be emphasized enough, given that textile outputs account for the vast majority of Pakistan’s exports. These outputsare valued at about $13.5 billion, making up for 61% of the country’s total share of exports.

It is essential to consider the structural impediments to textile sector growth if there is any hope of restoring Pakistan’s economic health in the foreseeable future.

The most crucial aspect hindering ourtextile sector from achieving its true potential is the imbalance in the economy: a direct result of the high level of interest rates.The consecutive hike in interest rates in recent times can be attributed to desperate attempts to counter high inflation, which is yet another matter of contention.

The bar chart below depicts the rising inflation over the last few months.

The strategy of countering high inflation with high interest rates brings to mind the idiom fighting fire with fire, and it is none other than the path to a healthy economy that burns as a result.

An economic formula whereby interest rates are raised for a certain period in order to stabilize the economy can possibly be deemed effective in certain Highly Developed Economies: a title which Pakistan’s economy is a long way off from attaining. HDEs tend to have surplus currency tied up in mortgages or consumer financing. Therefore, it is only logical that such a formula be limited in its application to those economies which are in a similar state, while a policy more suited to developing economies should be used in Pakistan’s case.

Furthermore, high interest rates belie the impression of a stable economy in the short run, while long-term economic health continues to be endangered due to the volatile nature of an economy with an interest rate as high as 13.25%.

The high interest rate and resulting influx of “hot money” into the Pakistan economy has several negative implications for Pakistani industry, and the textile sector is bearing the brunt of the pressure given the expectation to contribute largely to the country’s exports.

Presently, the textile sector has its order books at full capacity, and has managed to identify gaps where there is potential for additional capacity and upgradation, yet filling these gaps is proving to be an elusive task, given the high interest rate. Investments of $3-4 billion have been planned but no endgame is in sight when it comes to their implementation.

Furthermore, high interest rates not only curtail investment, but also make it virtually impossible for the concerned industries to remain profitable. The spike in interest rates has all but put a complete stop to investment, upgradation and technological advancement in various industries.

Subsequently, the low level of investment has worsened the state of affairs, particularly for productive sectors which are now struggling to maintain productivity. The abrupt rise in factory shutdowns and closing of textile businesses are causes for concern.

Furthermore, the cost of doing business increases indefinitely with the rise in interest rate, which also implies hindrances in access to capital, leaving businesses to fend for themselves and struggle to make ends meet with no fallback option. Investors are also less likely to put money into active projects as the high interest rates make these options volatile and high-risk.

All these factors result into a spillover effect with mass downsizing, stifled economic activity and stagnation in GDP growth. Thus, it comes as no surprise that technological advancement is rendered a distant fantasy for an industry facing an economic crisis.

A vicious cycle emerged where policymakers begin to scramble for shortterm solutions to dig their way out of their present misery - only to find
themselves in a bigger conundrum in the long run.

Below is a comparison of two graphs depicting interest rates over the last 20 or so years, those in highly developed economies as well as those in
Pakistan:

Through a comparative assessment, the Pakistan economy appears to be trapped in the preliminary stages of a crisis not unlike the one faced by
East Asian countries in the late 90s, and more recently by Egypt. If history is any indication, there is no easy way out of this grave Pakistan has dug itself into.

The natural tendency for policymakers at this stage seems to be advocating for the maintenance of the prevailing interest rate. This is because lowering it will undoubtedly lead to an abrupt withdrawal of “hot money” funds by investors, who will instantly seek out higher rates of return via other economies. This will translate into short term chaos, owing to the collapse of what appears to be holding up our economy at the surface level.

However, what is truly required is an analysis of the grassroots level implications of lowering the interest rate, and the long term factors which make it essential to do so.

Although the withdrawal of hot money financing will result into a massive short term burden that may appear difficult to fall back from, given the increased pressure on the Rupee and on the foreign exchange reserves that will remain, this reduction is crucial for restoring Pakistan’s economic health.

Due to the resulting decrease in the overall import bill, a lowered interest rate will allow for greater capital investments, eventual job creation and improvements in technology, research and development.

This will have particular advantages for the textile industry, and will be a welcome shift from the prevalent method of concessional financing and the challenges it presents. Given that around 90% of the textile industry consists of indirect exporters, the textile industry operates in a largely fragmented chain structure wherein separate entities exist for each function, be it printing, dyeing, weaving etc. The concessional financing that is set aside for the textile sector can thus not be availed by each of these separate fragments in the textile industry again, and therefore, it is not producing the desired impact.

A more suitable policy needs to be adopted that caters to this issue at the grassroots level. If certain funds are being allocated to the textile industry, it should be in a manner that allows for them to be availed by the entire chain.

A more adaptive financial model and a focus on more productive capital investments, particularly in technology, will have a wide, far-reaching impact that will bear fruits for generations to come. It will allow for a much-needed increase in our presently abysmal level of exports, and will also tackle the increasing burden of unemployment at the root. As we have often heard, good things come to those who wait, and desperate shortcuts towards stability make for long delays.

Therefore, the need for a long-term policy featuring lower interest rates cannot be underestimated. Its implications for a brighter economic future which generates foreign currency, employment and the economic betterment for the people of Pakistan cannot be denied.