An exclusive interview with Dr. Ishrat Husain, Governor, State Bank of Pakistan

Aug 05 - 11, 2002

The World Bank, International Monetary Fund, Asian Development Bank and other international financial institutions have repeatedly expressed their confidence in the resilience of Pakistan's economy. However, many Pakistanis still have negative perception about the economic fundamentals and credible performance of the economy, despite many odds. In an exclusive interview, Dr. Ishrat Husain, Governor, State Bank of Pakistan reviews performance of economy in the post September 11, 2001 era and expresses faith in the economic fundamentals enjoyed by the country. The point of satisfaction is that the country is following market based policies. However, the Governor believes a lot more has to be done.

In year 2001-2002 the biggest achievement of Pakistan was to secure its external sector. The debt indicators are improving. Foreign exchange reserves have gone up to cover more than seven months import bill from a situation where the country had three weeks requirement. Exchange rate has not only remained stable but has appreciated by 7 to 8 per cent during last one year. The confidence in exchange rate has allowed the country to absorb the various external shocks. If one looks at history, whenever there was an external shock there was speculative pressure on rupee. But this time, Since September 11, 2001, the country went through six different shocks and every time rupee withstood these strongly and there was hardly any pressure on the exchange rate. There has been significant change in sentiments of both the domestic and external factors on the viability of exchange rate itself.

The main contributing factors to this are: 1) the agreements with international financial institutions which allowed access to concessional loans. 2) There has been big upsurge in workers' remittances. Pakistan used to receive about 80 to 85 million dollars every month. Whereas now it is getting close to 250 million dollars per month. There is a combination of very strong vigilance on Hawalla and Hundi business in the US and the UAE. It is also due to elimination of premium in the kerb market and the efforts by commercial banks to streamline their own organization and distribution channel for the workers' remittances. 3) Improvement in Pakistan's balance of trade situation. The country did not suffer as much loss in exports as was envisaged soon after September 11. At the same time the country benefited due to reduction in its import bill as the crude oil and POL products prices declined. With the improvement in balance of trade, the country was able to achieve current account surplus, after a very long time, in the history of Pakistan.

A source of disappointment has been that the country was not able to achieve GDP growth target of 4 per cent. Contrary to earlier projections, it is now established that the GDP growth rate for the year 2001-2002 is about 3.6 per cent. The major difficulty was in the agriculture sector that was caused by the shortfall in irrigation water and continued drought like situation. Despite that food crops, sugarcane and cotton production was adequate to meet the domestic requirements. That helped in keeping rate of inflation under control. Inflation rate has been less than 3 per cent. This was not only because of improvement on supply side but also because food prices remained stable. Prices of various commodities in the international markets remained low due to global recession which did not allow prices of essential imported commodities to go up in the country. And the appreciation of rupee also helped in containing rate of inflation, lower than the target.

Another source of concern was that investment rate did not move upwards. This has been the fate of Pakistan that investment to GDP ratio has been declining for the last six years. To me, this is not a very healthy sign because it has adverse impact on employment, poverty reduction and growth. I am very concerned and disappointed at this continued decline in investment by the domestic as well as the foreign investors. There are a number of reasons but the main reason, I think, is the lower aggregate demand. Unless the private sector demand does not go up, investment will not rebound.

The government's fiscal deficit was kept under control. Revenue collection remained below the target but mostly due to reduction in value of imports. Due to external shocks as well as appreciation of rupee there was a decline in Pakistan's import bill that resulted in lower revenue collection. But, ultimately we were able to get over 400 billion rupee. The good thing was that deficit remained under control and if one takes one-off adjustment, there is a decline in underlying fiscal deficit. This will help Pakistan in improving debt indicators even further in the future.

One of the steps taken by the central bank was to ease monetary policy. The central bank has been able to reduce discount rates by 5 percentage points and the T-Bill rates by 6 to 7 percentage points. However, the corresponding decline in banks' lending rates has been only 2 to 2.5 per cent. In real terms, the interest rates are still high and the central bank would very much like to see the commercial banks to lower interest rate.

I am quite happy with the performance of commercial banks except a few DFIs and specialized banks and the loss incurred by United Bank Limited (UBL). If one takes these on one side then there has been a very healthy growth as far as earnings or profitability of commercial banks is concerned. Some of the banks have doubled their profit as compared to last year. I am pleased with the quality of new loans. Of course, the banks had a serious problem with the stock of Non-Performing Loans (NPLs), but at least, the quality of new loans is much better and the chances of these becoming non-performing or defaulted in the future are much lower.

Provisioning by commercial banks has improved significantly and banking sector is much healthier today compared to previous years. The central bank ensures that the banks make sufficient provisions against the NPLs. Advances are growing but NPLs are not and the stock of defaulted loans is reducing. The level of NPLs is marginally lower and the point of satisfaction is that net NPLs, after provisioning, have come down to Rs 131 billion. Defaulted loans have reduced from Rs 172 billion to Rs 168 billion by end March this year. If the return on deposits have to be kept attractive and efforts are aimed at reducing lending rates, the spread will definitely shrink. This is a good sign, because depositors should not be penalized. While the central bank wants to ensure that return to depositors remains adequate, we also want the banks to reduce their weighted average lending rates. It can be achieved when intermediation cost and administrative expenses are reduced so the benefit could go to consumers, depositors and borrowers.

Having said this, I am not particularly pleased with their credit allocation to SMEs and also the expansion of consumer financing. I have been urging the banks to focus attention towards consumer financing and SMEs. The response has not been quite good.

For the first time in the history of Pakistan commercial banks have actually exceeded their target for agriculture sector loans. The growth has been about 23 per cent as compared to previous year. If you compare their performance with ADBP, it is much better. Private domestic banks, on their own, have also started extending credit to the agriculture sector without any mandatory requirement from the central bank. This is a very positive trend for the economy.

To strengthen commercial banks, the paid-up capital requirement has been enhanced to one billion rupee. Most of the banks have been able to meet this except a few. As regards domestic banks they do not face any problem. Only a few banks from neighbouring countries are still struggling to meet the requirement. Some of the foreign banks have asked for extension in last date. Platinum Bank is negotiating change of hands because the previous sponsors could not fulfil the capital requirement. We hope that the new owners will be able to meet the enhanced limit within the available time.

In the matter of privatization of 51 per cent shares of UBL, the central bank approved all the three bids. The central bank also suggested to the Privatization Commission to ask the highest bidder, Muslim Commercial Bank (MCB) to further improve its bid. Consequently MCB submitted the enhanced bid to Rs 12.3 billion. Now we have to look at its revised funding plan. We hope this transaction will be completed sooner than later. The central bank will transfer the management of UBL to a credible buyer only. A bank is not like a manufacturing concern. It has depositors' money and it is SBP's responsibility to make sure that the bank goes to the right sponsors.

As regards Habib Bank Limited (HBL), the Commission has received very good response. Previously the GoP intended to first enlist the bank on local stock exchanges and sell its 5 to 10 per cent shares. Encouraged by the response of strategic buyers, the government now intends to sell 26 per cent shares of the bank anlongwith the transfer of management to a strategic buyer. HBL is a big entity and the GoP wants to share the upside potential with the new buyer. If its performance improves under the new management the GoP would be a beneficiary. The GoP has already disposed of its shareholding in MCB but still owns 49 per cent shares of Allied Bank of Pakistan (ABL). The GoP is in the process of divesting its share in ABL. The Expression of Interests (EoIs) have been invited for the sale of remaining shares of the GoP in Bank Alfalah.

The Securities and Exchange Commission of Pakistan (SECP) has issued circular and given time to brokers, who are on the board of directors of listed companies, to relinquish their directorship. The same is also applicable on the brokers who are on the boards of financial institutions. While the SECP had stipulated four months time to make this change in case of listed, the SBP has given one month only for compliance. These people approached the central bank and wanted a similar time frame. My contention is that our efforts are aimed at improving the level of corporate governance. Therefore, the time limit is a very secondary issue. Once the central bank issues directive, it also would like to ensure compliance in substance and spirit.

I am satisfied with the outcome of first phase of structural reforms in the financial sector. We are moving from an administratively controlled financial sector to market driven institutions. The efficiency and soundness of financial sector are of paramount interest. The central bank has also become a more effective regulator and supervisor of financial institutions. I am pleased with the mergers and acquisitions going on in the financial sector. It has been decided to make complete bifurcation of the responsibilities of the SBP and the SECP. The central bank now looks after the banking sector and all the NBFIs will be regulated by the SECP.

The second phase of these structural reforms will be completed when HBL and UBL are privatized and there will be greater competition among the players. It appears that about 10 to 12 strong and efficient players will emerge after mergers and consolidation. The customers will benefit from the competition among these strong and efficient players. It will help in achieving the twin objectives of better return to deposits and reduction in average lending rates.

The government had gone to the Supreme Court with the request that it had tried its best to implement the Riba Judgement, made certain achievements and could not go beyond that. The GoP urged the court to reconsider this issue, whether we can have the full system transformed from conventional banking system to Islamic banking overnight or we are allowed to have two parallel systems operate simultaneously. The court was informed that financial institutions have developed certain products and the country has first Islamic commercial bank Meezan Bank. The central bank has allowed the commercial banks to establish subsidiaries and open windows for Islamic banking. The Central bank is in the process of appointing Sharia Board to help in the development of new products based on Islamic injunctions. The SBP is a member of Islamic Financial Services Board which is coordinating supervison of Islamic banks. The GoP is of the view that if the people of Pakistan, both the depositors and borrowers, decide that they want to switchover from conventional banking system to Islamic banking system, it has to be their own decision. People should not be forced to move from one system to the other system and it is in the larger interest of people to decide for themselves. Every individual and business entity should be allowed to make its own decision. There were two extreme point of views and that was the reason the court was requested to make the decision after hearing to the all concerned. There is also a difference of opinion about the definition of Riba. While some people say only Usury is Riba, others believe charging of a fixed/predetermined rate is Riba. We are not in a position to make that decision. The Supreme Court has now sent the case back to Sharia Court which will take up the case once again.

It is a general feeling that banks, by entering into leasing business, are violating their original mandate. The fact is leasing constitutes only a small percentage of their total business. However, the central bank intends to make some amendment whereby banks will be allowed to undertake large scale leasing business by establishing subsidiaries, which will be regulated by the SECP. The Modarabas floated by the banks are on equal footings and do not enjoy any extraordinary advantage. I want banks to undertake more of consumer financing business. It is an area which has a lot of potential for growth. At the same time there is no restriction on banks on undertaking housing finance activity. I consider it part of commercial banking activities.

As regards promotion of housing finance activities, the SBP provides funds at 8.5 per cent to such companies for onward lending at 10.5 per cent per annum. The objective is to provide finance for low cost housing on which larger spread cannot be allowed. It is similar to export refinance on which a spread of 1.5 per cent is allowed. The housing finance companies have made a representation but the SBP point is that the scheme is only for low cost housing and not for large borrowers.

Lately a number of foreign banks have closed or sold their Pakistan operations. It is not because Pakistan is no longer an attractive place to do business. The decisions were made due to shift in the global policies of these banks. Bank of America made the strategic decision to be a domestic US bank. ANZ Grindlays Bank was takenover by Standard Chartered Bank. Societe Generale (SG) is still present in Pakistan. They did not want to have full-fledged commercial banking operation and became a joint venture partner in Meezan Bank. Emirates Bank International wanted to consolidate its position in the Gulf region. Therefore, the more appropriate expression is that foreign banks are following their global strategy and they are not forced by whatever is happening in Pakistan. The number of banks is becoming smaller all over the world due to mergers and acquisitions and Pakistan is no exception.


Dr. Ishrat Husain took over the charge of the office of the Governor, State Bank of Pakistan, on December 2, 1999. Prior to his appointment as Governor, he was Director for Central Asian Republics managing the World Bank's relations, programmes and policies with these countries. Earlier, he was Director, Poverty and Social Policy Department of the World Bank responsible for the Bank's policies and strategy development in the areas of poverty reduction, gender, NGOs and public sector reform and governance. He was Chairperson of the World Bank's Public Sector Group.

Dr. Husain served as Chief Economist for Africa during 1991-94 and later became Chief Economist of the World Bank for East Asia and Pacific region focusing mainly on China. He was Chief of the Debt and International Finance Division where he helped develop the World Bank's strategic approach to Latin American debt problems which subsequently resulted in Bank's participation in the Brady Initiative of Debt Reduction. As the World Bank's Resident Representative in Nigeria he led the Bank's team that assisted Nigeria in formulating its Structural Adjustment Programme of 1986. Earlier on, he was responsible for designing World Bank's programme to support Ghana's Economic Reform Programme.

His most recent book "Pakistan: The Economy of an Elitist State" is a culmination of a two year research project he undertook on Pakistan. His most recent paper on "The Political Economy of Reforms: Case Study on Pakistan" has been published by Pakistan Institute of Development Economics. He is Adjunct Professor of Economics at Karachi University with supervision responsibilities for doctoral dissertations.

Dr. Husain holds Masters degree in Development Economics from Williams College and doctorate in Economics from Boston University. He is a graduate of the Executive Development Programme jointly sponsored by Harvard, Standard and INSEAD.