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Shift of banks’ focus from Govt securities to private sector credit: A positive impact

Banking sector of Pakistan has revealed massive growth and potential over the years. There is a considerable expansion in the profitability of the banking sector demonstrated by performance and stability indicators. Mainly in operations of economic development, banks as financial intermediaries play an important role and their efficiency can also influence the economic growth. There are important implications of changes in the interest rate on the economy. In the banking system, impact of interest rate changes has been a significant issue. As compared to other institutions, banks are more sensitive to the changes in the interest rates.

In FY17, interest rates may rise on growing demand for private sector credit and because banks may try to make up for high tax incidence through more interest income. This is a more likely scenario if the monetary policy is not eased any more. A possible build-up in inflationary pressures building after rise in international oil prices is one key factor that may bring an end to interest rate cuts by the State Bank of Pakistan. The exchange rate, too, may come under pressure as nothing concrete is in sight for a strong growth in net forex earnings vis-à-vis remittances and exports. If private sector credit does not rise fast and if the government borrowing from banks does not go past the targeted level, the banks may find it difficult to increase interest rates particularly if the monetary policy is kept stable or eased further.

The government’s plan to borrow from banks will have an impact on interest rates movement in the context of overall economic environment. This higher borrowing does not mean banks will be employing funds at higher rates. Banks’ liquidity levels and private sector credit demand will play a decisive role in interest rates movement.

In FY2016, private sector credit intake remained concentrated in mining and quarrying, livestock and, in the industrial sector in food and beverages, textiles, electricity, gas and water supplies, construction, coke and petroleum, chemicals, rubber and plastics, fabricated metal products, electric machinery, communication apparatus, and automobiles etc.

Some of these sectors like mining and quarrying, livestock, textiles and construction can show strong credit demand also in FY2017 partly due to the budgetary measures to boost activities in these sectors and partly because high growth in their outputs (except in textiles) in FY2016 should keep their credit appetite to sustain output growth. Credit demand can also come from those sub-sectors of agriculture like crop farming, fisheries and horticulture that did not do well in FY2016 and are expected to perform better in FY2017 after budgetary subsidies and incentives. Besides, modest to moderate growth in credit, demand of petroleum sector is also expected from the oil marketing companies that invested heavily in capacity building in FY2016.

Gross advances to the private sector surged by Rs. 410 billion or 10.6 percent during this quarter as against the rise of 7.7 percent in the corresponding period of last year. The increase was largely attributed to the textile sector followed by energy and sugar sectors. The surge in credit may be due to a variety of factors, including the lagged effect of a consistent easy monetary policy. It may be mentioned that SBP had reduced the policy rate by as much as 425 basis points (bps) since November, 2014 which was translated into a 373 bps reduction in weighted average lending rate. In addition, better economic conditions, financing for the China Pakistan Economic Corridor (CPEC) and improved security and energy supplies may have contributed to higher private sector financing. Banks’ reduction in investment in government securities and higher growth in deposits also created the space for higher private sector lending.

Obviously, it would have been much better if a reduction in government securities held with the commercial banks was brought about by a decline in budget deficit. Since this was not possible due to a weak fiscal position, the government reduced the borrowings from commercial banks by resorting to higher borrowings from the SBP which could stoke inflationary pressures in the economy.

Profitability of the banking sector came under pressure due to lower interest rate environment, receding investments in PIBs and T-Bills and maturity of high yielding long-term bonds. It is good to see that deposit mobilization has picked up pace which was an improvement, considering stagnation in deposits in the last couple of years. Also, the solvency of the banking sector remains robust and the financial intermediation seems to have improved over the year. As for the prospects in the medium-term, a lot will depend on the monetary policy formulated by the State Bank of Pakistan (SBP), fiscal position of the government, financing sources to meet the budgetary deficit and overall economic environment in the country.

The World Bank in its latest report projected that fiscal deficit was projected to be 4.8 percent in FY2017 as against 4.1 percent revised target of the government. This widening is primarily driven by slower increase in government tax revenues (both federal and provincial) coupled with decline in non-tax revenues. The shortfall in tax and non-tax collection would mean more domestic and foreign borrowings to bridge the budget deficit.

The government has planned to raise Rs1,900 billion through the sale of treasury bills to banks during the last quarter for the current fiscal year to meet the budgetary financing. The banks would be glad to lend funds to the government at the prospect of rebound in interest rate, driven by an untamed inflation. March consumer price inflation reached two-year high of 4.9 percent due to surging food prices. The SBP, however, kept its key policy rate for April-May unchanged at 5.75 percent.

The writer is a Karachi based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan

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