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Reduction in the financial cost alone cannot boost investment in the manufacturing sector

Jan 17 - 23, 2000

This is the second time since mid 1998 that the State Bank of Pakistan has reduced the interest rates. Similarly, the rate of return on various products of National Saving Schemes (NSS) have been reduced. The objective was to facilitate borrowing by the private sector. However, some of the analysts say that reduction in interest rates alone cannot boost borrowing by the private sector. This is only an effort, by the GoP, to reduce interest expense on its borrowing. This impression is supported by the continued efforts to curtail yield on T-Bills.

Some of the analysts say that the financial institutions in Pakistan suffer from 'surplus liquidity crisis' and the GoP is just taking the advantage. This seems to carry weight if one looks at the prevailing 'Badla rate' in the capital market. This rate has virtually came down to the level of interest rates charged by the financial institutions. This decline has been despite increase in the daily trading volume — increased demand for funds. The KSE-100 index has almost doubled since June 1998.

According to these analysts this surplus liquidity is due to two factors, hardly any fresh borrowing by the private sector and outcome of November 1999 recovery drive. This surplus is expected to further increase with the commencement of the second phase of recovery from defaulters of less Rs 100 millions.

One wonders if the interest rates are low why the private sector is shy to borrow. One of the reasons is that the corporate sector is no longer borrowing the money for BMR and expansion. The other reason is that the corporate sector itself currently suffer from surplus liquidity. This is evident from the fact that 319 listed companies declared dividend for the year 1998-99.

Some of the analysts say that the reduction in rate of return on NSS products has caused serious concern for the investors. These products were preferred due to higher rate of return and security of investment. The level of distress has intensified due to delays in encashment and payment of interest by National Savings Centres (NSCs). While there may not be any instruction from the GoP to defer such payments, the Eid rush could have been the reason for slow processing at the NSCs.

However, many investors were ready to believe that the GoP may put embargo on encashment and stop profit payment after the recent judgement of the Supreme Court regarding 'Riba'. Another reason for recent run on NSCs was the rumour that the GoP may deduct the already paid interest from the principal amount at the time of redemption.

Such rumours were easily accepted by the investors. It is a common belief that NSS are not fully collaterized and in case of any run for encashment, NSCs will not be able to redeem the full amount. This is based on the experience of foreign currency accounts (FCAs). These accounts were frozen on the eve of nuclear tests conducted on May 28, 1998. This was done due to precarious position of foreign exchange reserves. The successive governments had used a very large percentage of these deposits for debt servicing and foreign trade. Knowing that the GoP would not be able to honour withdrawals these accounts were frozen. Many investors in NSS now fear that GoP will not be in a position to redeem if there is a sudden and large scale requests for encashment.

One of the priorities of the current economic managers is to restore the confidence of investors. Reduction of interest rates is part of this exercise but it has failed to lure the investors. Investors are still reluctant to make any long-term investment in the manufacturing sector.

Most of the sectors which were attractive in the recent past are no longer viable due to over-supply. These are textile, sugar, synthetics, fertilizer, energy etc. Information technology and energy sectors offer enormous potential but also require huge investment and joint-venture formation.

Foreign investors are keen in forming join-ventures but unless local investors come forward no such facilities can be created in the country. Amicable resolution of HUBCO issue can play a vital role in restoring confidence of investors. But there has been no head-way even after the dismissal of Nawaz Sharif government. Similarly, privatization of state enterprises offer investment opportunities for both local and foreign investors but the process has been extremely slow due to lack of commitment. There has been a proposal to sell the shares of state enterprises through stock exchanges but final decision has not been made as yet.

It is encouraging to note that investment is being made in real estate, capital market and gold. However, it is necessary to channel the funds to manufacturing sector. This can only ensure economic recovery and boost GDP growth rate. The reduction in interest rate can also help in containing cost-pushed inflation and enhancing the competitiveness of the local manufacturers. Therefore, it is necessary that GoP removes all the impediments and restore the confidence of local investors. Till the time local investors are shy neither the foreign investors will come to Pakistan nor privatization of state enterprises will be possible.