Banking sector: Feeling the squeeze

For the past several years now, banks have been complacently engaging in low-risk lending to the government, while the private sector is ailing due to a severe cash crunch. All the while the industrial sector continues to shrink due to a drought of liquidity, in addition to other factors, and the foreseeable future holds no better prospects. Inflation is not likely to go into single digits, and since controlling inflation is usually the criteria driving the State Bank of Pakistan’s (SBP) determination of interest rates, there is little possibility of low-interest lending coming the private investors’ way.

Cash-strapped industry

It is self-evident that a dearth of capital is a deterrent to industrial growth, and at this juncture most of the capital available in Pakistan’s banking sector is being directed to the state rather than private investors. Since the past few years, government borrowing from the financial sector has been unregulated, and currently almost half of all domestic credit is with the government sector.

According to provisional data provided by the SBP, total credit to the government currently stands at Rs3.2 trillion, signifying a rise from Rs2.5 trillion a year ago. In comparison, credit to non-government borrowers is currently Rs2.8 trillion, a sluggish increase from Rs2.7 trillion a year ago. According to the auction calendar released by the SBP, the government is expected to borrow Rs1.07 trillion in the current quarter – October to December 2011 – of this fiscal year. The private sector is not expected borrow anything even remotely close to that amount.

Local and foreign economists based at the IMF and the ADB have consistently warned that commercial borrowing by the government is squeezing out private sector borrowers, but this is just part of the problem. Contrary to common perception, while high levels of government borrowing is a deterrent to growth, it is not the only factor, and reducing interest rates alone will not have a significant positive impact on industrial development.


A plethora of reasons for industrial ruin

Other factors like the power crisis, gas shortage and the worsening law and order situation have played a big role in retarding industrial growth. Several businessmen have moved their operations to destinations like Malaysia, Bangladesh and Dubai, predominantly because of fuel and electricity scarcity and a lack of security.

Moreover, Pakistan’s financial situation with regard to foreign borrowing looks rather bleak. In a recent statement, Werner Liepach, the ADB’s country director for Pakistan said that they will not be providing any budgetary assistance to Pakistan. “For budgetary lending there is a need to have consensus among international financial institutions on macroeconomic stabilisation of the country or at least a letter of assessment from the IMF is required before giving budgetary support loans,” he said. Given this situation, there is still little chance that domestic borrowing by the government will reduce.

Maintaining Pakistan’s balance of payments is also going to become an increasingly difficult task for the country’s financial managers. Since exports have remained more or less stagnant in the $20 to $25 billion window for the past five years or so, the only reliable source of foreign exchange is remittances.

Sluggish flow of foreign funds and remittances, the pressure of debt repayment and the daily running expenses have thus forced the government to rely excessively on funding from commercial banks.

Will a lower interest rate increase private borrowing?

But with the SBP slashing interest rates from 13.5 to 12%, will there be more credit available for the private sector? Will businessmen line up for loans at this new interest rate?

Most analysts believe that even at 12%, there won’t be many takers from the private sector because of low confidence, inadequate capacity utilisation, and most importantly, the sheer lack of power to run industries.

“Investor confidence is at an all-time low, and industrialists will be unwilling to borrow until interest rates go to single digits in the current economic climate,” says Hammad Aslam, Head of Research at BMA Capital. “While banks may have to seek other sources to maintain profitability, they will generally be happy with the returns they are getting from government borrowing.”

There are also other problems. The government is also looking at a proposal to deal with the issue of circular debt through Pakistan Investment Bonds (PIBs). “It is still uncertain that banks will invest in PIBs since it is a long-term undertaking and confidence is low,” says Khurram Schezad, Head of research at InvestCap securities.

This move may give the government some fiscal breathing room but it’s still unclear whether the government will invest this fiscal build-up in development projects. However, the PIBs will definitely drain more credit out of the banking system which could have been alternatively channelled to the private sector.

Bleak prospects for the private sector

Schezad added that the banking sector will probably not be too keen to lend to the private sector as they would think that businessmen may not be able to repay the loans in the current environment.

Businessman commonly complain that banks are reluctant to extend loans to them as it involves risk and requires a lot of work for banks.

According to this view, it’s much easier for banks to make money by making short-term investments in government papers.

Head of Research at Standard Capital Securities, Faisal Shaji, however, has a more hopeful view of the business climate in the future. “With elections right around the corner, the current government seems to have realised that it needs to bring in some business-friendly measures,” he says. “Borrowing will most likely pick up in the coming calendar year, when wind power projects and LNG import begins, since both are capital-intensive businesses.”

Shaji believes that the government will reduce the policy rate further under the mandate given to the new governor of the State Bank, Yaseen Anwar.

Khalid Iqbal Siddiqui, research head at Invest & Finance Securities, however, is not so hopeful about the prospects of the private sector. He argues that private banks will be more than happy to continue lending just to the government, even at lower interest rates, simply because it is convenient for them.

Muzzamil Aslam, senior economist at JS Global Capital says it simply: “Banks are not eager to lend, and the private sector is not keen on borrowing. But banks will need to look at other avenues to maintain profitability by the year end, so this may change.”

The government again requires large sums of money as public sector giants— PIA, Pakistan Steel Mills, Wapda and Pakistan Railway —are all looking for bailouts that cannot be financed from the revenue generation that the government expects in the current fiscal year.

Moreover, the money borrowed by the government has not been productively invested. Analysts say that borrowed funds have been spent in unproductive ways— for combating terrorism in the country and reviving melting public sector giants.

The government’s reliance on banking sector financing for fiscal and budgetary support also needs to be regulated. Though banks have been making profits, the economy continues to suffer. But until the general investment climate improves, most businessmen don’t really care, because it’s not really money they are short of right now, but rather ideas of what to do with that money!

Published in The Express Tribune, November 2^nd, 2011.