Apr 5 - 11, 2010

The key factors which are responsible for the fall in demand for credit by the private sector include chronic energy shortages, law and order problem, decline in external demand due to the global recession and the central bank's tight monetary policy. Lower-than-target credit off-take by the private sector reflects a disappointing situation, according to the analysts.

In the last financial year, the private sector credit off-take from the banks showed negative growth amid slowdown in the domestic economic activity, surge in non-performing loans (NPLs) and availability of alternate avenues to extend credit. However, credit to public sectors enterprises (PSEs) witnessed a significant increase of Rs83billion, depicting a massive growth of 57.63 percent during last fiscal year. The credit expansion by the banks to the PSEs surged to Rs144.5 billion in 343 days of last fiscal as against Rs61 billion during the corresponding period of fiscal year 2007-08. The domestic banks lending to private sector showed negative growth of Rs3.274b from July 01 to June 13, 2009 as against net credit of Rs383.5 billion in fiscal 2008-09.

The NPLs, which have reached Rs432 billion, pose a challenge for the banking industry in the country. The NPLs of the banking industry witnessed a rapid increase for the last one and a half years or so and almost doubled since calendar year 2007.

Commercial banks' lending to private sector during the Oct-Dec quarter of current fiscal year increased by 4.16 per cent and unlike previous quarters the growth in credit off-take was widely shared by different leading sectors of the economy, according to the Quarterly Performance Review of the banking issued by the State Bank of Pakistan last month.

Agriculture sector on which the country depends largely for its economic growth, including the largest export-oriented textile sector, absorbed much less credit than the target set by the central bank during the first eight months of the current fiscal year. The credit disbursement to agriculture sector during the eight months remained at Rs144.7 billion, though 10.5 per cent higher than the Rs130 billion disbursed last year but was far behind the target for the current fiscal, according to the central bank. Analysts believe that the one of the reasons for lower flow of agriculture credit is the scarcity of water, which would certainly hit the agriculture output during the current fiscal year. Surprisingly, though the prices of agriculture input have gone up, which means more liquidity should be absorbed by the sector.

The central bank's tight monetary policy is one of the key reason behind the private sector's falling demand for credit.

The country's central bank in its monetary policy statement for April and May maintained its discount rate at 12.5 percent, as a downward adjustment runs the risk of fuelling already high inflation. The CPI inflation rose 13.04 percent in February from a year earlier after climbing 13.68 percent in January, after the government raised electricity and gas tariffs. Analysts expect inflation to stay on the higher side as commodity prices remain high and subsidies are ended. In the last fiscal year, the average inflation was 20.5 per cent, which means the currency lost its purchasing power with the same level. The inflation is again in double digits as the February figure (year-on-year basis) was 13 percent.

The country's central bank has been pursuing a tight monetary policy for the last three years to tackle price inflation. The central bank cut its key policy rate by 150 bps to 12.5 per cent during this fiscal year (2009-10) but kept the rates unchanged in its three previous monetary policy reviews because of rising inflation.

The country however, witnessed a fresh surge in inflationary pressures due to removal of oil and power subsidies and the government's growing needs for more borrowing from commercial banks to cover its budgetary deficit. The government raised power tariffs in January by 14 percent and increased gas prices by 18 percent to help bridge the fiscal deficit. The removal of power subsidies left a negative impact on inflation.

The government's tight monetary policy has disappointed the local industrialists and traders who contend that unchanged discount rate would further increase the cost of production and destroy the industries, as it is already suffering from exorbitantly high business cost. Pakistan is on its way to becoming one of the most expensive countries of the world. The increased interest rate has made doing business increasingly expensive. Last year witnessed closure of many industries and several more remained under the threat of closure following rising cost of doing business.

The expansion in private sector credit will only increase when the real economic activity gains momentum. The increased power tariffs and power outages have already crippled the industry, causing widespread discontentment in the business circles. A significant reduction in discount rate bringing it down to single digit is essential to rescue the ailing industry. The industry is facing power shortages and squeezing local and international demand, while banks are not risking their money to support the private sector.

High interest rates are marginalizing the private sector, according to the experts. India's Reserve Bank kept problems of businessmen in mind and maintained low interest rates to keep the stimulus it provided last year to boost growth. Inflation in both India and Pakistan is now almost the same. However, the policy rate in Pakistan is three times higher than India. Analysts contend that the central bank should provide relief to local investors by lowering its key policy rate to single digit.

Some analysts believe that the rising debt would leave nothing for the private sector and contraction in credit for private sector would lead to further slump in business activities. Instead of resorting to foreign borrowing, the government should take measures to reduce non-development expenses and widen tax base by bringing more sectors in to tax net to generate more revenues.

Many believe that cutting interest rates to single digit level will produce multiple benefits for the economy, as it will lower the cost of doing business, give a strong boost to business and industrial activities, provide easy credit and loaning facilities to trade and industry, promote better investment and exports and generate more tax revenue for the government.