June 8 - 14, 2009

The banking system confronted with heightened credit risk, which is transpired in significant increase in Non-Performing Loans (NPLs), yet interestingly the profit margins of the banks have also increased significantly.

The banking system earned before tax profit of Rs 26.2 billion for the March, 2009 quarter that was higher compared with Rs10.5 billion in Dec 08 quarter, though lower than corresponding quarter of 2008.

As far as the infected portfolio was concerned, the Non Performing Loans (NPLs) of the banking system increased to Rs 379 billion (Rs 313 billion in Dec-08) giving infection ratio of 11.5 percent and net infection ratio of 3.9 percent. The loan loss provisions to the extent of 69 percent cover NPLs, but due to increased loan provisions in absolute amounts, earnings of the banking system came under pressure and remained lower than corresponding quarters of last couple of years.

The banking industry was able to maintain its resilience and showed improvement in key solvency indicators despite current economic situation in the country. However, due to deterioration in macroeconomic indicators, the credit risk remained high.


Pakistan's economy continued to show macroeconomic stability in the third quarter of the current 2008-09 fiscal year (FY09) as the Government focused on macroeconomic reforms and the economy benefitted from a sharp decline in international commodity prices and other favorable developments.

Third Quarterly Report of the State Bank of Pakistan said, inflation began to decline, the current account deficit narrowed substantially with a corresponding stability in the exchange rate, and fiscal discipline was maintained with the fiscal deficit being reported to be 3.1 percent of GDP for July-March FY09.

"While this improvement in macroeconomic indicators is very encouraging, the economy is not out of the woods yet. Major macroeconomic indicators show underlying weaknesses which, if not addressed, could hamper economic recovery."

The recent easing of inflationary pressures is indeed encouraging as the headline inflation - measured by consumer price index (CPI) - dropped to 17.2 percent on year-on-year (YoY) basis in April 2009 from its peak of 25.3 percent YoY in August 2008. In particular, a sharp downtrend in food inflation is a welcome development as this component of CPI affects low income groups the most. CPI food inflation fell from its peak of 34.1 percent YoY during August 2008 to 17.0 percent in April 2009.

The downtrend in inflation owes to both, favorable international and domestic developments, as well as a deceleration in domestic demand. The latter, in particular, reflects the monetary tightening by the State Bank, as well as the complementary improvement in fiscal discipline, especially after November 2008. It is worth noting that the acceleration in the fall of inflation is becoming visible only after the monetization of the fiscal deficit was halted, the report added.

It is projected that in FY09 average CPI inflation in the current fiscal year is expected to stay between 20.5 percent and 21.5 percent, whereas Gross Domestic Product growth is likely to be 2.0 percent to 3.0 percent and fiscal deficit may hover between 4.0 and 4.5 percent of GDP.

In order to support industry and particularly the export-oriented sectors, which were pressurized by the impact of the global recession, SBP introduced measures such as easing access to concessional financing schemes, and lengthening maturities. The central bank also injected appropriate liquidity to meet banking system's increased demands for commodity operations and settlement of circular debt. However, by April 2009, broad money (M2) growth was still quite weak, at 1.9 percent year-to-date, down sharply from 8.4 percent in the corresponding period last year, reflecting continued deceleration in domestic demand. "As a result of this, SBP projections suggest that deceleration in inflation will be much sharper in the next few months. This is also evident from the successive fall in the core inflation during March and April 2009, it added.

Thus, as other macroeconomic indicators improved further, this allowed the central bank a 100 bps reduction in the policy rate, bringing it to 14 percent effective from April 21, 2009.

The record wheat and rice harvests together with the likelihood of good production in minor crops and of fodder have increased expectations that growth in the crops sub-sector of agriculture will exceed the FY09 annual target. "A reasonable performance from the livestock sector, supporting all this, will help take the overall agri-sector growth close to, or over, the annual target," it added.

However, growth in large scale manufacturing (LSM) has been negative for the tenth consecutive month in March 2009, the longest period in which production continued to shrink. LSM growth dropped by 7.6 percent during July-Mar FY09 compared with a 5.0 percent rise in the corresponding period of FY08. This is the major drag on the prospects of improving real GDP growth, it added.

The anticipated weaker performance of revenues, and increase in expenditures both point to the risk of slippage in the fiscal deficit target, and a contingent increase in financing requirements. Similarly, resurgence in international commodity prices poses risks to the assessment of a continued sharp deceleration in inflation in the months ahead. In particular, a rise in international oil prices would have adverse consequences for domestic inflation as well as the external account balance, it added.

In addition, the international inflows under financial and capital accounts are relatively lower compared with the preceding years, causing a rise in overall external account deficit. A fall in financial inflows is the result of combined impact of both external and domestic factors, the report said. "While, Pakistan's ability to access international financial market is constrained, any shortfall in external inflows would add to pressures on monetary policy.

In short, the limited gains in key macroeconomic indicators should not lead to complacency as the quality of these improvement and challenges to economy are some factors of disquiet.

SBP report has suggested that reduction in development expenditure is not desirable, as it would have detrimental impacts on country's human and physical infrastructure. "In the medium term, the only viable way to achieve sustainable improvements in fiscal accounts is to raise the tax-to-GDP ratio through increasing the tax net," it said and added this is because a substantial reduction in current expenditures is not possible without significant reduction in the size of government machinery, due to inflexible interest payments and expenses under defense and civil administration.

The Central Bank has also underscored the need to implement second-generation reforms to improve governance, strengthening institutions and reforming legal as well as regulatory system.



Pakistan's banking system has great potential for further investment said Salim Raza, Governor SBP at launching ceremony of Silkbank Limited, formerly Saudi Pak Commercial Bank Ltd..

Raza said the performance of country's financial sector, which is largely dominated by banks, has been outstanding throughout the current economic situation.

The banking sector has over the years nurtured itself in a way that it is able to withstand some of the shocks it has faced in the last 18 months or so. 'The banking system is on strong footing and has long term potential, a feature which has served to attract a substantial amount of Foreign Direct Investment (FDI) in the sector, with established global financial institutions now active participants in the domestic financial sector,' he said and added that the banking industry is well-governed and has witnessed outstanding financial performance during the last few years. 'With strong regulatory oversight, there has been a significant enhancement of capital and risk-weighted capital adequacy,' he said and added that stringent loan provisioning requirement has built sufficient reserves against the Non Performing Loans' (NPLs') portfolio.

Raza said that State Bank always encourages customer's focus & service standards and added: 'we have no doubts in the ability of the management of Silkbank in delivering high levels of service through innovative products and a pro-active service attitude.'

He appreciated the sponsors of Silkbank i.e. International Finance Corporation from the World Bank Group, Bank Muscat and Nomura for their interests 'in our market and their commitment to Silkbank, which adds stability to our economy'.

'As a regulator, it is clear to us that the direction of Silkbank's strategy is positive and measured, and we believe that Silkbank will deliver on its commitment to its stakeholders,' he added.

'We have followed the restructuring of Silkbank about which its management has kept SBP fully aware of at all levels and we believe that Silkbank's efforts will yield very strong results in the long run', Mr Raza added.

Azmat Tarin, President of Silkbank, in this remarks thanked the State Bank for its support during the restructuring process. The ceremony was attended, among others, by senior officials of State Bank, Silkbank and executives of banks.