MONETARY TRANSMISSION AND BALANCE SHEET CHANNEL IN PAKISTAN: An Investigation using Firm-level Data

Umme FARWA*, Syed Faizan IFTIKHAR**, Asghar Ali**

Central banks use diverse monetary policy instruments to maintain the inflation rate and real
output. The impact on the real economic activity of the changes made in monetary policy is realised
over the course of diverse channels of the Monetary Transmission Mechanism (MTM).
The current study examines the balance sheet channel of MTM with reference to non-financial
corporations in Pakistan in the last seven years. Employing a two-step system GMM estimation
framework, the following features of the results are highlighted. Rising interest rates translate
into a deteriorating interest coverage ratio and, ultimately, a weaker financial position. Sectorwise
analysis exhibits a less pronounced negative relationship for firms belonging to the services
sector. The findings strongly favour the theory of asymmetric MTM effects and suggest that
the balance-sheet channel applies to all firms, but it is pertinent for small firms.