The State Bank has clearly ruled out any reduction in the interest rates in fiscal year 2006, indicating that a change, if warranted, is likely to be on the upside, through further monetary tightening.

Dec 04 - Dec 10, 2006

Economics is a complicated subject which requires diversified expertise and not just confining to mere banking and currency management. Tightening of the monetary policy alone cannot check high levels of inflation and price hike. The swelling interest rates have however raised profitability of the banking sector in the country and attracted leading international banks towards either acquiring or merging with banks in Pakistan or planning to launch their operations here.

There is also an unimaginable spread between deposit and lending rates - ranging between five and six per cent on average against two per cent worldwide. The Senate Standing Committee on Finance on November 23 has also expressed its serious concerns over the existing high rates of interest on loans that have multiplied the cost of doing business and damaged the industry and exports.

However, briefing the committee, State Bank Governor Shamshad Akhtar said that the compulsion of ensuring proper liquidity management and to control inflation had made the government increase the rate of interest. She claimed that the "real interest rate" was not higher than 1.5 per cent. She not only indicated further monetary tightening but in the second quarterly report on the state of the economy fiscal 2006, the State Bank of Pakistan has clearly ruled out any reduction in the interest rates in fiscal year 2006, indicating that a change, if warranted, is likely to be on the upside, through further monetary tightening.

The report sent to the federal legislature, says: "Despite evidence of the slowdown in credit off-take, relative to last year (which saw exceptionally high growth in net credit off-take), and a visible weakening in manufacturing growth, the SBP monetary policy stance has come under debate. Ironically, this centres on a very welcome weakness in inflationary pressures and particularly the deceleration in core inflation. On the one hand, some stakeholders (including manufacturers and exporters) point to the fall in inflation and stress the need to immediately lower interest rates to reduce the cost of production and investment in order to strengthen growth. On the other hand, the SBP is also exhorted by other stakeholders to tighten its monetary posture even further, by increasing rates immediately. It is argued that this is needed to reduce inflation to the low single digit, support long-term growth, and curb speculative pressures (alleging that asset bubbles have been created and need to be pricked), even at the risk of substantially depressing economic activities in the short-term. Both arguments merit some consideration."

The SBP says: "The problem with the first argument is simply that despite the decline, domestic inflation rates remain relatively high and, while slowing, fiscal year 2006 real GDP growth is also expected to remain strong, at over 6 percent. However, on the other hand, there is also an unimaginable spread between deposit and lending rates - ranging between five and six per cent on average against two per cent worldwide. High interest rates are bar on the high pace of exports and especially the export of textiles.

"Comprehensive insight is required to coordinate and consult all the stakeholders of the industry to achieve the desired goals of the budget 2006-07. SBP, while introducing a tighter money policy and as a follow up, has repeatedly been advising the commercial banks to cushion some of their lending rates, in order to keep burden and financial cost to the private sector within manageable limits. But, the banks have not complied. As a result, the banks" spread the difference between its deposit and lending rates rose still higher to 7.5 per cent, in August this year, according to SBP data. The spread for eight months to August, 2006 averaged 7.3 per cent, up from 5.8 per cent in the like eight months of calendar 2005.

The SPB data for July-September, the first quarter of fiscal 2007, unveiled last week, shows the private sector has slowdown its credit off take. The credit growth during this quarter was merely 1.5 per cent. Bank credit to private sector during July 1 to October 11 declined by Rs5 billion, compared to like period of 2006, SBP data indicates.

However, credit by investment and specialised banks, filled the gap and raised the overall lending to private sector to a plus Rs1.5 billion. Total credit off take by private sector in 2006 itself was Rs333.7 billion, "significantly lower than the increase during the same period of 2005," when it was Rs378 billion, SBP reported.

Fiscal 2006 had recorded a 19.5 per cent private sector credit growth down from 29.7 per cent in 2005. The average lending rate of all banks works out to 10.64, but 12 per cent seems to be the norm. The interest rate, however, now is rising. Interest rate was at a record low of 5.0 per cent in July, 2003, but blue chip corporate borrowers were getting it at even 3.0 to 4.0 per cent. It means the woes of the private business, too are genuine, while the government and the central bank are now trying to watch interests of the common citizen who is beset with rising inflation, particularly the high cost of food. The profit rate paid to depositors averages 3.14 per cent, leaving a large profit in the form of the spread. The July-September quarter also saw a larger and faster repayment of loans to the banks. Some of those loans were repaid even prior to their scheduled dates.

Private sector borrowing has slowed down, principally because of low off take by textiles and cement industries. These two industries had, in the past, been in market for big bank advances for expansion of their production capacity, upgradation and modernisation. Zakir Mahmood, country's senior banker and President of the big Habib Bank Ltd. attributes the decline in private sector credit growth and off-take to "largely to tight monetary policy". But, he, like projections by other bankers, is of the opinion that credit off take will go up during the upcoming cotton crop season which puts operations of the textile industry production in full gear.

Textile industry, in particular, has invested $6 billion over the last five years, as it was gearing to benefit from the start of the WTO regime that abolished textile export quotas. But, it has not benefited in exports to the desired extent. The industry which recorded textile exports of just 8 per cent in the first quarter of 2007, blames its poor performance on stiff competition in the global market places. Its key competitors are China, India and Bangladesh. It claims, the governments of these three countries are subsidising exports, besides providing a range of other cost-cutting benefits. The other reasons seem to be that Pakistani textile industry may still have to further improve quality and product range, besides lowering its cost of production. The cement industry has, over the recent years, enlarged its capacity to cater to domestic demand fuelled by construction boom in the government and private sector here and for the large scale reconstruction in neighbouring Afghanistan.

Pakistan also is initiating its new mega water and power sector projects besides highways and other physical infrastructure projects that will spur demand for cement. The newly installed and expanded capacity will be in production between now and 2008. It will increase its demand for working capital. Bankers are of the view that power sector is the next major potential borrower. A number of private and public sector power projects have been announced. All of them will require large bank funding and credit spread over several years. At the same time, consumer demand for a range of products from autos to household electronics, and housing loans is growing. The industry, overall, is also becoming more capital intensive in order to improve its productivity, efficiency and to cut costs. This programme will require all sorts of equipment, both imported and domestically produced. It will include equipment ranging from heavy construction machinery to bulk transport vehicles and machinery for electronically operated production and processes.

Bankers also note that in the first quarter of the current fiscal, besides textile and ready-to-wear garments, growth is also continuing for food and beverages, petroleum products and household electronics. Several other industries, however, have recorded a slower growth or their production has even declined. These trends, again, are attributed to costly credit, and higher inflation that has reduced the real purchasing power of the consumers. The projected $28 billion imports in 2007, a target that is likely to be exceeded, will raise the future demand for advances. The export target has been set at $16.8 billion. In fact, foreign trade financing has been a major profit-spinner for banks over the last five years. The bankers expect this trend to continue. In the recent past, SBP has raised the cash reserve requirement and the statutory liquidity requirements collectively by five per cent. It means that all the banks will now have to keep 25 per cent of the cash deposits with the SBP. A substantial rise in domestic savings, preferably for long-term is also an anti-inflationary measure as it reduces current consumption. The increase in the discount rate and the cash reserve has also pushed up Karachi Inter-bank Offered Rate (KIBOR) to 9.07 per cent per year and the three-month rate to 9.77 per cent.

Global interest rates SBP measures have continued to remain ineffective and that too with multiplier effects. For one, it has badly damaged the volumes of exports. The export refinance rate was cut by 1.5 per cent to counter the slowing down. Lending to private sector has been moralised. The average short-term lending rate is 10.1 per cent so far, which may rise as a result of the measures taken by the central bank. The US Federal Reserve has raised its short-term lending rate to 5.25 per cent. The Bank of England has recently increased the interest rate by 0.25 points. The Bank of Japan has ended its zero rate of interest and come up with a quarter per cent interest. The European Union has reluctantly raised its rate to three per cent lest it hurts its economic recovery. South Korea has an interest rate of 4.5 per cent. India's short-term lending rate is 6.34 per cent, while Pakistan's lending rate is 10.1 per cent. The Bank of China has increased its lending rate to 6.12 per cent and raised its deposit rate to 2.52 per cent. It has raised both the rates by a uniform 0.27 per cent.


The export of textile products declined by 7.10 per cent to $1.625 billion during the first two months (July-Aug) of the fiscal year 2006-07 as against $1.749 billion during the same months last year. The report of the Federal Bureau of Statistics (FBS) showed that almost all textile products, excluding towels, cotton yarn, and cotton carded or combed and tents witnessed negative growth during the months under review.

The product-wise details of textile commodities showed that the export of readymade garments declined by 3.63 per cent during the fist two months of the current fiscal, over last year. Exports of raw cotton and cotton cloth have declined by 59.66 per cent and 9.77 per cent, respectively. Knitwear and bed-wear exports have decreased by 8.30 per cent and 11.20 per cent. The export of made-up articles, including other textiles, declined by 35.31 per cent, art, silk and synthetic textile by 53.89 per cent and other textile materials down by 27.86 per cent during July-Aug 2006, over the same months last year.


The rising interest rate has started hitting the industrial sector, particularly the textile sector. The profitability of the textile sector, which also happens to be the key sector, fell sharply despite a number of incentives offered by the government. The cost of financing has gone up while the cost of input also increased because of increasing interest rates. According to one report, the cost of financing for the textile sector went up by 83 per cent during the financial year 2005-06. The report further mentioned that the profitability of the textile sector fell by 29 per cent during the same fiscal. This fall can be dangerous for the country as the textile sector is a significant source of revenue as well as responsible for generating huge direct and indirect employment. The loan towards the textile sector has dropped sharply and borrowing by the textile sector last year declined by 28 per cent.

The report has stated that the first quarter credit off-take by the private sector was almost negative, compared to the first quarter of last year, which will ultimately affect the final output of the industrial production.


Many bank officials feel that the lending rates have been increased due to the prevailing high inflation rate to maintain a large banking spread. The banks' average banking spread is still over 7.5 per cent and high inflation is used as a means to justify it.

Profitability of the textile sector in the fiscal year 2005-06 has declined by 29 per cent as it stood at Rs5.3 billion as against Rs 7.5 billion. The tight monetary policy, which engaged more liquidity of banks with SBP finally resulted in slow monetary growth and less credit off take by the private sector. However, another impact of the policy emerged in the shape of costlier money. The government has been opposing curtailing credit flow towards the private sector but the monetary controlling authority has been advocating the cutting of huge credit flows, which was essential for low inflation.