FOZIA ISHAQUE (fozia.ishaque@hotmail.com)
Apr 20 - 26, 2009

Since July 2006 State Bank of Pakistan has been repeatedly increasing the discount rate, in order to curtail inordinate, rising inflation. The tight monetary stance is adopted also to restrict government borrowings for budgetary support and on the other hand provide more credit to the private sector. Interest rate has been mounting by leaps and bounds during last two years. From July 2006 to date, the discount rate has been increased by 600 basis points, including 500 basis points increase in 2008 alone. However this tool was absolutely not up to snuff inflationary pressure which is becoming more severe with the passage of time.

The SBP's monetary policy also seems to be ineffective in controlling return of a potential default culture and escalating non performing loans (NPLs), witnessed in the 1990s. Higher interest rates are opening an exit door for inefficient and unscrupulous borrowers who always try to avoid repayment of borrowed money with high interest rates. Non-performing loans (NPLs) of the banking system rose from Rs278 billion at the end of September 2008 to Rs313 billion by the close of December, 2008, increasing the infection ratio to 9.1%. Satisfactory earnings, however, enabled the system to cover these loan losses.

As a matter of fact, this higher discount rate is taking its toll on the depositors hard earned money who are not getting a proportionately higher return on their saving. Consequently the lofty disparity between markup charged and paid is yielding very high spreads for the banking industry.

The high spread shows that banks are charging high interest rate from creditors and paying low interest to depositors. Depositors in Pakistan are receiving negative returns even at a time when banks are booming. According to the State Bank data weighted average lending rate for all banks in January 2009 was 14.66% while average deposit rate was just 6.88%. It indicates that only the depositors are made to pay the heavy prices for ever increasing profits being earned by the banks and also for high salaries and fringe benefits being paid to the CEOs and other employees of banks. Banking sector spread was 7.78% in January 2009, which is 3 basis point higher on month-on-month basis and 72 basis points higher than the spread in January 2008.

It is an astonishing fact that global economy is in the clutches of regression and global banking industry is incurring huge losses but Pakistani banks have earned a profit of Rs50 billion in 2008. An unreceptive tone against this repeated rise in the lending rates is also enunciated in the circles of business communities. Most of Pakistani banks in 2008 posted profits despite negative impact of banking system failure in the developed economies.

The situation looks encouraging for banks but awfully discouraging for depositors. SMEs are also suffering from this grim situation. Same is the case with large scale manufacturing where negative growth in the first eight months of FY09, resulted due to increasing cost of capital including cost of credit.

Banks are lending in the range of 18% to 27%. The highest cost is paid by small borrowers as consumer loans are charged with highest interest rates.

Increasing number of SMEs are being pushed out of business due to high capital cost, high inflation, and step-motherly treatment given to them by the banks and the investment companies. Big and influential borrowers can however get any amount of loan without much difficulty. They are also entitled to enjoy loans write-off and rescheduling. The high interest rate regime may be leading to the path of default culture of the 1990s, when the accumulated bad loans approached Rs300 billion, a big figure in today's currency value.

Now the government has hinted at reducing the interest rate while the International Monetary Fund also showed inclination for cutting in the interest rate. Cut in mark-up rate is possible in April when monetary policy would be reviewed. The banking spread will come down with the cut in the policy interest rate. Negative return to depositors has been under serious criticism and banks are being held responsible for it.


The bottom line of the discussion is that Pakistan is entering into a rather challenging phase of growth. The economy is cooling down after three years of above average growth produced by a combination of benign global economic environment and manipulated economic drivers cosmetically made up by the then government. However, the impending economic slowdown may dampen the growth rate as well as the banking industry. The present tough environment will heighten the credit risk for banks and affect earnings due to increased loan losses and constrained incomes.

Given the current economic scenario, where we are faced with many difficulties and challenges, it is throbbing to see this plight of financial sector cannibalizing the economy and intimidating expansion in industry when it is needed the most. This scenario is clear manifestation of declining confidence of foreign investors. Nevertheless if the policy direction is corrected timely, investors both foreign and domestic will not hesitate to invest their money in this country in spite of a slowing economy. Once inflation is curtailed and interest rates are revised down and fiscal deficit narrowed down to around 3% of the GDP in two years, investors will bring in their money.