June 1 - 7, 2009

Every economy has a specific economic structure based on a few fundamental economic factors which have potential to revive an economy. And every economic decision is based on this structure to grow and stabilize an economy. Sticking to those fundamentals is cornerstone of economic development.

Pakistan is unfortunate in a way that every incumbent government neglected the fundamental economic factors and pursue different polices for economic development. Before 2001, Civilian government pursued development approach which was totally export oriented. In 2001, when military government took over the civilian government, it switched to development strategy with a major focus on consumption driven economic growth. Consequently, Pakistan economy grew at unprecedented rate of 7% on an average from 2004 to 2007. Aim was to create sufficient domestic demand. During this period consumer financing increased tremendously and it gave stimulus to consumer spending, resulted in unprecedented GDP growth.

After 9/11, foreign capital flew into Pakistan and as a result of excess liquidity in financial sector interest rate declined to very low levels. Military government capitalized on this opportunity and promoted consumer financing to boost domestic demand. Resultantly, every economic sector benefited from it and expanded to meet growing demand. But this strategy proved a short-lived phenomenon. Unfortunately a major chunk of consumer financing was misused and funds borrowed were actually being used for speculative purposes in real estate market and hoarding of essential food items owing to lack of regulatory supervision. Besides, fiscal deficit increased. Resultantly, inflationary pressures got momentum caused by demand-supply gap, which gave rise to interest rates hike. Thus, steep fall had been seen in consumer financing.

The slowdown in consumer financing was attributed to two main reasons. First the increase in interest rates and second low demand for consumer items specially automobiles, as a result of increase in their prices. Borrowers unable to service their loans installments and started defaulting. Banks opted relatively cautious lending to consumer sector. Hence, all efforts to create consumption led growth turned out futile in the long run.

But we cannot neglect the benefits consumer financing offers. We have examples of United States of America and China which have also pursued consumption led economic growth. If prudent and effective consumer financing policies are implemented along with regulatory supervision, it can help in reviving Pakistani economy. Any move to boost private consumption will have a much larger impact on the GDP growth than any other measure, says Dr Ishrat Husain, former Governor of the State Bank.

For last two years, Pakistan economy has been growing at very slow pace. Both external and internal factors are responsible for it. It is the right time for the government and regulator to draft and implement effective consumer financing policies. Discount rate after touching 15% is now showing downward trend. State Bank in latest auction decreased yield on benchmark treasury bonds, which is an indication that in near future interest rate will further go down, which will create excess liquidity in the market. Consumer financing is the best way to utilize it to boost economic growth.

No doubt, as a result of this measure growth rate will take off but at the same time excessive consumer spending results in further fall in savings to GDP ratio and steep rise in consumer debt level. There is a trade-off, if proper steps would not be taken at beginning, consumer financing will lead to damage to the economy in long run as happened in the past.

What needs to be done?

1. If consumer-led growth strategy is to be made successful, it is imperative that the consumer rights are protected. Government should implement strict consumer protection laws and establish consumer protection courts.

2. Government and regulator must ensure that funds borrowed are not misused for speculative and hoarding purposes. And it should put in place a mechanism to levy taxes and penalize those who undertake such transactions.

3. Central bank must compel banks to advertise actual product terms and do not try to trap customers through deceptive advertisements.

4. Currently banks concentrate on urban areas. Banks should explore new markets for consumer financing. Our majority of population is living in rural areas. New and innovative products should be designed according to their needs.

State bank of Pakistan should compel banks to implement effective risk management policies. Risk management policies -like credit appraisal system- should be drafted at higher management level and explicitly spelled out through the institution. Policies should be flexible enough to adjust them according to changing dynamics of an economy.