Oct 29 - Nov 04, 2007

Pakistan's economy has grown strongly over the past few years, at an average pace of 7 percent. On the demand side, private consumption, boosted by continued rapid expansion in consumer credit and higher workers' remittances, continued to be a lead contributor to GDP growth for the third year running whereas private sector credit expanded by about 24 percent. In recent years, the Government's strong macroeconomic policies, high growth rates, increases in pro-poor spending, and worker's remittances have all contributed to a steep decline in the incidence of poverty and the unemployment rate. Pakistan's banking and finance sector grew by over 20 percent since last three years amid the eight percent expansion in the services sector in Pakistan. While the income from core banking activity has increased due to higher business volume, earnings are also expected to improve due to ventures into consumer finance, housing finance and enhanced lending to the agriculture sector. Consumer loans of the Pakistani banking industry grew by Rs 72.4 billion or 29 percent in 2006 to reach Rs 325 billion. Share of consumer finance in overall loans increased to 13.5 percent in FY 2006 from 9.4 percent in FY 2004 on the back of persistent higher growth.


According to the SBP the overall quality of the consumer finance has been good, but it has started experiencing some erosion recently. During 2006, the quality of consumer portfolio witnessed some deterioration as Non Performing Loans (NPL) of this sector increased to Rs 7.0 billion from Rs 3.1 billion in FY 2005. As compared to other sectors, consumer finance has so far shown a very low level of NPLs in Pakistan. In fact at 2.2 percent, the NPL ratio is lower than Corporate (6.5 percent), SME (8.8 percent) and Agriculture (21 percent). This level is lower than many countries including Malaysia, Philippines and United States. The share of consumer credit in total private sector credit in the country is still lower at 14 percent compared to other countries. This share is 24 percent in India and 30 percent in Indonesia.

Product wise analysis of consumer finance reveals that personal loans have the highest share of 41 percent. Auto finance, mortgage loans and credit cards follow with 32 percent, 15.1 percent, and 12.1 percent market share, respectively. In terms of exposure, the level of indebtedness of consumers in all the products except auto and consumer durable has been rising persistently. Exposure per borrower in credit cards rose from Rs 26,000 in FY 2005 to Rs 32,000 FY 2006, in mortgage loans from Rs 1.982 million in 2005 to Rs 2.025 million in 2006, and in other personal loans from Rs 89,000 to Rs 100,000. It dropped from Rs 430,000 in FY 2005 to Rs 411,000 in FY 2006 in auto loans and from Rs 29,000 in 2005 to Rs 22,000 in 2006 in consumer durables.

Since mortgage and auto loans are adequately secured, the rising exposures in these products may not pose serious credit risk threats to the banks. However, rising level of consumer's indebtedness on account of personal loans and credit cards, which are considered unsecured lending, warrant attention of the bank's management. When compared with the total number of bank depositors having deposit size of Rs 10,000 and above, the number of credit card customers is significantly lower i.e. less than 10 percent. While the amazing growth in consumer finance has contributed to a surge in banking profitability, it has also raised concerns from certain quarters. The increasing loan infection ratio of this segment does merit some critical inquiry as the stability of the banking sector due to its close proximity with the real sector and its importance as a saving medium is critical for the sustained growth of any economy.


Traditionally, given the credit constrained economy, banks had not focused on the development and marketing of consumer finance products. However, this picture changed totally following the exceptional liquidity influx since FY01; the resulting availability of consumer finance products, easing of regulations, development of bank's infrastructure, and above all, significant improvement in consumer awareness supported the growth of this market segment even when interest rates were to rise. In addition to housing finance, car finance and personal loans the State Bank has allowed all banks to give loans to general public for purchase of consumer durables (like televisions, washing machines, deep-freezers and refrigerators, computers, etc. Exceedingly facilitated by state bank regulations and configuration of the monetary policy commercial banks have broadened the sphere of consumer finance products and are catering to every section of society. The liberalization of consumer financing by banks is in line with the government policy to fuel industrial growth as stated in the trade policy.

Profound credit circulation for durables and immovable assets resulted, among other things, in net outflow from small saving schemes to the tune of Rs44.9 billion during FY 05 as against an inflow of Rs1.6 billion in FY 04, Rs126.2 billion in FY03 and Rs84.9 billion in FY 02. Bank deposit holders have been hit really hard. Consumer credit has certainly contributed to increased private consumption. The major focus which induced the State Bank to encourage consumer financing was (1) to give the economy a demand-pull boost given that it had been in the clutches of a decade long recession, (2) to enable banks to diversify their loan portfolios in a low interest rate environment; and (3) to provide the middle class, the backbone of the economy, an easy access to bank credit.

Another related (and very significant) development, that became visible during Q1-FY07, was that for the first time, lending by commercial banks for housing finance outstripped the lending by the specialized banks in the respective areas. The financial sector reforms of the past decade (including changes in the legal framework such as making bounced cheque a criminal offence, and permitting financial institutions to repossess property falling defaults without recourse to the courts), coupled with the fiscal prudence seen in the last two years, is now making a significant real contribution to the economy by expanding the availability of goods and services to a larger segment of consumers.


During the first ten months of the current fiscal year the average inflation rate as measured by the change in consumer price index (CPI) stood at 7.9 percent compared to 8.0 percent last year. During FY 05 as against the inflation rate of 9.3 percent, the average return on bank deposits was no more than 1.8 percent meaning a negative real rate of return of as much as 7.5 percent. The rate of return to depositors thus continues to be negative in real terms and was so at 6.7 percent in the current year. The overall rate of return does not indicate the position of small deposit holders, who get nothing even in nominal terms and lose the value of their capital to the full extent of inflation when they maintain the minimum balance required by banks. If not, they are subject to a hefty service charge on a monthly basis, which can wipe out their meager balance in no time.

During FY 2006-07, consumer credit registered relatively slow growth in contrast to year 2005-6 when it saw an expansion of Rs84.7 billion as compared with an increase of Rs45.9 billion in FY 04. Unlike FY 04, when the growth in consumer finance was led by personal loans, during FY 06 auto loans and housing finance have also contributed significantly in the growth of consumer finance. At the end of FY06, outstanding bank advances by way of consumer finance was of the order of above Rs255 billion, of which Personal Loans accounted for above Rs.110 billion; Transport above Rs75 billion; house building above Rs35.0 billion; credit cards around Rs25 billion; consumer durables above Rs5 billion and Others Rs5 billion. During FY 06 consumer lending expanded by approximately Rs40 billion. During FY 06, increase in consumer credit accounted for only 16 percent of the increase in and 2.3 percent of the absolute amount of private consumption expenditure.


Increasing liquidity in the financial sector combined with serious concern on the part of government to improve GDP growth rate, has prompted economic managers to embark on a development strategy with a major focus on consumer led economic growth and that too be domestic driven. This was contrary to the previous development approach, which was totally export-oriented. Consumer financing has tremendously increased during the last two years and that too was available at a mark-up rate generally as low as seven percent per annum until recently. Foreign investment is also flowing into consumer-focused industries and services. Emphasis on consumer financing was to create sufficient domestic demand for consumer items, which are effective substitute for imported goods such as automobiles and electronic items, particularly household electronic gadgets and cellular phones etc.

Extra- ordinary surge in consumer spending occurs when a substantial rise occurs in GDP growth rate and per capita income resultant of expansionary macro-economic policies or is the outcome of tilt of affluent towards speculative activity, which initiates demonstration effect on all sections of the society. No doubt, consumer financing has given impetus to manufacturing of electronic items and automobiles and also housing industry, but unfortunately a sizable share of consumer loans thus released have been misused and actually have facilitated speculative trading in real estate and stock exchange securities. To seek full benefit of rise in GDP growth rate via consumer led development strategies, there is need to put in place mechanism of protecting consumer rights. Hence total disregard of this fact by policy makers in the wake of steep rise in petroleum products impacting overall price level has raised inflationary rate to two digits in recent months. As a result, State Bank's intervention to curb inflation has raised the interest rates and private borrowings for purchase of automobiles and investment in housing have considerably reduced.

Accordingly, a set back has been occurred with regard to capacity to save of middle and lower middle income class making it practically impossible for them to service loan installments if they desire availing car or housing loan. Hence, apparently all efforts to stimulate consumers' demand will turn out futile in the long run. Moreover, speculative trading in property and building material has made it impossible even for middle income class, who commands the buyers market, to own a house of their own. In a year's time, prices of property in certain posh areas have registered an increase of about 150 percent, whereas according to a news report, in Housing Scheme No 33 of Karachi where until recently prices of plots were affordable for middle and lower middle income class have now gone up by 300 percent. Hence very purpose of liberalizing housing finance through banking channels has been defeated. No new major housing project has been floated by the government in the last three years, hence speculative buying and selling of existing properties has pooled the ownership either with land Mafia or few speculators.

The benefits of government policy to provide shelter for all, which is one of the indicators of social sector development, has not trickled down to the level of population where it is needed most. The majority of lower middle income class urban population employed in formal and informal sector is living in rented houses, which consumes almost 50 percent of their total monthly income. Further, it is being felt with greater intensity that benefit of low cost consumer financing has given fillip to hoarding and speculative trading in essential food items. Lack of attention of policy makers towards the need of having regulatory mechanism has contributed significantly to price pressure in various segments of both industrial and agriculture sector. Most important being automobiles, cement and food items, thus compelling people to enhance their liabilities by getting trapped in vivacious circle of borrowing both from formal and informal sources to meet necessities of life. Recent report appearing in leading newspapers regarding heavy withdrawals from National Saving Schemes reveals that major chunk of these funds have been invested in stock exchange securities and property. Assets of investors from lower income class have been depleted after big crash experienced in stock market. It has some repercussions on prices of property also, which have been slashed down by 20 to 25 percent in quite a number of housing schemes where an unabated speculative trading was going on since last 1Ω year.

The wealth losses being encountered by this segment of population who had indulged in speculation and also those who are not in a position to service their car loans, will not only enhance quantum of non-performing loans of financial institutions, but also totally wipe off movable and immovable assets of the borrowers. Thus a major chunk of population would automatically be dragged down to poverty level. The strategy of promoting spending no doubt stimulates economic growth rate, but it needs extensive supervision and legislative protection to consumers to combat speculative and other unethical practices in vogue in trading of goods and services. Artificial inflationary conditions created by speculators and hoarders of essential food items erode the savings and enhance household debt level, thus bringing slow down in effective demand for goods and services, which ultimately stagnates growth of economy. It is not the case of a low-income developing country like Pakistan alone. Even in economically developed countries, where efforts were made to halt cyclical recessionary trend via liberalizing consumer financing, there also, despite legislative protection available to consumers, speculative activities got hold of the trading process. This happened especially in case of housing and stocks exchange securities.

In 2001, when US economy was receding fast and stock market had fallen to its lowest ebb, stimulation of household spending was considered as a feasible strategy not only to sustain domestic growth, but also to support achieving global economy targets, which are linked to US economy growth trends. No doubt, as a result of this measure growth rate took off but at the same time excessive consumer spending resulted in drastic fall in savings ratio to country's GDP, steep rise in consumer debt level. In addition to these economic adversaries, general public was exposed to house bubble caused by steep rise in prices of real estate. Accordingly, in case of Pakistan immediate steps are needed to be taken to protect consumer's interest by arresting speculative and other unethical practices through imposition of heavy taxes and penalties on such transactions. Otherwise liberal consumer-financing by banks in the face of heightened urge on the part of everyone to adopt life styles in vogue in economically developed countries, depicted through electronic media, now in reach of all strata of society would make the people more extravagant. This will further reduce rate of savings and real investment, leaving little hope for the country to come out of dilemma of growing poverty.


Sustainability of this nation-wide unusual surge in consumer spending irrespective of its legitimacy appears to be doubtful at this juncture as it has already been experienced in case of stock exchange securities and trading in properties. A little jerk in speculative trading can bring spill over effect on consumer spending at all levels of income. Very liberal car financing facilities offered by banks and leasing companies have prompted even lower middle income class to have a car. Interestingly, at least a part of the recent increase in inflationary pressures may be attributable to a rise in consumer demand due to rising availability of consumer credit. Resultantly, in the face of sharply rising oil prices and overall inflationary trend, about 20,000 default cases have already been reported by banks relating to car financing alone. In addition to borrowing for car purchase, loan liabilities of this segment of population have further increased due to costly credit availed through (much publicized) credit cards and short term loans for financing consumption purchases. Household equity of these unfortunate loan defaulters will ultimately turn out to be negative. Already saving rate has seen an almost stagnant growth from 17.2 percent of the GDP in FY 2005-06 to 18 percent in 2007 in which domestic saving is low. Consumer debt levels have risen considerably. In order to improve the state of affairs the first obvious step should be to gradually revert to the old debt equity ratio of 60:40, if not the ideal 50:50, from the current general ratio of 70:30.(For housing finance this is 85:15) In bank credit, as a matter of policy, preference should be given to those borrowers who maintain a higher proportion of equity. In any case, household saving has to provide the bulk of domestic saving. The trend in household saving has been stagnated. The stagnancy has been both in quantum of saving and as a percentage of GDP. This should have rung alarm bells for the authorities, but no such concern is visible and it is "All is well," so long as external resources are available to meet the current national needs.


The crucial importance of saving and investment for sustainable economic growth is universally recognized. A developing country in its very early stage has low income and domestic saving constraint. This can be eased by external resources supplementing domestic resources. As the economy takes off, increased incomes enhance the capacity to save and if used for actual saving, this sets in motion a virtuous circle of increased income resulting in increased saving and investment, leading to further increase in income. After some time, this enables the economy to become self-reliant, not needing the crutches of external resources. Pakistan is perhaps unique not to conform to this normal economic phenomenon with the least hope of becoming self-reliant in foreseeable future. In recent years, the process seems to have been reversed, as higher growth rate, instead of resulting in increased domestic saving, has been accompanied by a declining rate of domestic saving and greater dependence on external resources which are now more in the nature of external debt liability. Healthy growth in the economy and corresponding interest rate environment over the past few years kept up significant growth in consumer finance. However, the recent inflationary tendencies and the subsequently rising interest rates in response to curb the inflationary pressures may hurt not only the growth of consumer finance in future, but may also impact the repayment capacity of the borrower. The consumer finance, though a growing area of activity in Pakistan, still needs ardent reforms so as to improve basic indicators and domestic as well as national saving both in quantum and as a percentage of GDP.