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UNDERSTANDING THE LENDING ENVIRONMENT OF BANKS.

Byline: SAAD ANWAR HASHMI

The State Bank of Pakistan (SBP) has announced reduction in policy rate in light of reduction in inflation in the country and to help increase credit to consumers and manufacturing concerns. The main concern for SBP is to manage the balance of payments position and curtail inflation, which will result through reduction in rate. SBP reserves were US$6.7 billion in April 2013 whereas inflation reduced to 6.6 percent in March 2013. SBP is yet to retire $838 million in IMF loans during remaining period of FY13 and made payments of $2.2 billion by 3QFY13. With pressure on reserves, SBP can only receive respite if foreign inflows are expected, which are unlikely. SBP has so far played an active role in managing the parity between rupee-dollar through which is likely to further devaluate the local currency relative to the dollar with the IMF payments in the near future. Depreciation of the rupee relative to the dollar has been 4.2 percent from June 2012 to April 2013.

Pakistan is a net importer, therefore, any devaluation in the exchange rate against the dollar will make imports expensive and put further pressure on the reserves. Though exports due to such devaluation are expected to grow, however, considering rise in input cost, such differential may be negated making prices unattractive for the export markets. The Monetary Policy, however, cannot work in isolation considering external shocks e.g. international oil prices, recessionary impact, devaluation in interest rates or government borrowings. An encouraging sign are worker remittances averaging more than $1 billion a month and expected to cross $15 billion in FY13.

Pakistan's economy has already suffered due to corruption, political situation and law and order situation. Coupled with the European crisis and reduced trading opportunities from Pakistan with the country risk, SBP started reducing the policy rate. The international oil prices continue to be volatile and not expected to be maintained below $100 per barrel since high oil prices translates into higher GDP of OPEC. Pakistan has witnessed consistent revisions in oil prices as the government uses this tool for revenue generation in the form of tax. Though inflation is effected due with supply side issues, one of the core reasons is SBP is government borrowing, which have yet to be reduced. If oil prices decrease, any such decrease will be negated through the devaluation of rupee against the dollar which is likely to increase the import bill and causing inflation.

Despite the above challenges and borrowings from the Central Bank to meet budgetary deficits, loans to the private sector have increased. Since July 2012 to date, loans increased by Rs173 billion as compared to Rs56.8 billion during the same period last year. Advances to large scale manufactures increased 2.9 percent, which is low but encouraging. SBP since the beginning of FY12 has consistently reduced the discount rate, cumulative decline to date being 450 bps. Reduction in interest rate alone has assisted credit off take. SBP in light of lowering of inflation has given an incentive to the economy to boost the private sector through expansion of credit with hopes to increase production and GDP growth. A source for liquidity pressures in the economy showing sluggish economic growth and foreign direct investments could substitute low tax base.

SBP has stressed time and again that the government must devise fiscal and energy sector reforms and plan foreign financial inflows to mitigate uncertainty and pressure on reserves. It stressed that government should not borrow from the banking sector through treasury bills, which continues to affect the private sector through crowding out. Upto March 29, 2013 borrowings from SBP reached Rs853 billion as compared to Rs925 billion in the same period last year as against full year estimates of Rs484 billion. Since government securities yield a healthy risk free return, banks prefer financing the fiscal deficit through investment in fixed income securities rather than focus more on taking risk and extend private sector credit, which declines investment to GDP ratio.

The industry ADR which at times used to be 75 percent in 2005-06 has now reduced to 52 percent which shows that banks continue to remain conservative and only try to yield the maximum out of the existing portfolio SBP will continue to fund the government provided inflation is manageable. The government continues to provide subsidies, which are a major expense to the economy considering low tax base. The government currently meets all expenses through SBP borrowings and has failed to increase tax base.

The competition in the banking sector is intense with smaller and midsized banks pushing to pull deposit from larger banks offering competitive and attractive rate on liability products. SBP time and again has encouraged banks to provide a healthy return to its depositors whereas banks strive to lower the rate of return which in turn increases the banking spread to improve profitability. Since the return on deposits is a cost to the bank, in an ideal situation, no bank would like to incur this cost to squeeze its spread. Due to low returns, depositors find alternate mediums for investment by depositing funds with National Saving Schemes (NSS), Mutual Funds and Stocks. These are the same deposits which are required for advances. The best example is the constant rise in KSE-100 index which shows the people are finding high yielding avenues of returns. When KSE reached 16,000 there was speculation that the bubble will burst.

The KSE-100 index later reached 17,000 and is currently at 20,530 points, which is the highest-ever in history of Pakistan's stocks market. KSE has once again with capital gains and returns have proven to be the best stock market in the world. Private sector credit will not increase solely with reduction in interest rates as the country has to provide an enabling environment for private sector credit to grow. Though private sector disbursements have increased, it is yet to be seen if the growth is sustainable.
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Publication:Pakistan & Gulf Economist
Geographic Code:9PAKI
Date:May 26, 2013
Words:999
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