WOES OF BORROWERS
HIGH INTEREST RATE, SHORTAGE OF ENERGY PRODUCTS AND RISING COST OF DOING BUSINESS CAN ONLY ADD TO NON-PERFORMING LOANS
SHABBIR H. KAZMI
Apr 5 - 11, 2010
High interest rate is maintained in Pakistan by the central bank in an attempt to contain inflation. The last reduction in discount rate was announced in November 2009. The trade and industry has been demanding reduction in rate to 1) contain eroding competitiveness in the global markets and 2) spur much needed new investment for enhancing production capacities, creating job opportunities for poverty alleviation, but all in vain. It is true that that the IMF wants inflation rate in the country must be brought down but keeping interest rate high and persistent increase in electricity and gas tariffs and also withdrawal of subsidies are fueling inflation.
Growing delinquencies have affected quality of the assets of the banking sector. Commercial banks have become more stringent in the evaluation for financing proposals. This is evident from the meager credit offtake by the private sector.
According to the State bank of Pakistan non-performing loans (NPLs) of the banking system witnessed a relatively lower rise of Rs34.2 billion during H1-FY10 compared with a strong increase of Rs72.4 billion in the corresponding period a year ago. This slowdown was evident in corporate sector's NPLs and mainly the result of a sharp deceleration in advances growth, and improved repayment capacity of borrowers due to: 1) relatively stable input prices, 2) falling interest rates, 3) a mild recovery in the domestic economy, and 4) high earning from arrival of better cotton crop.
Though, the lower pace of NPLs growth in H1-FY10 released some pressures on asset quality of banks, the provisioning requirements for infected loans saw a marginal rise. More specifically, provisioning increased by Rs27.5 billion in H1-FY10, slightly higher than the rise recorded in H1-FY09. This anomaly is perhaps due to a change in the composition of incremental gross NPLs. In particular, the gross NPLs in the loss category increased sharply in H1-FY10 compared with H1-FY09.
A sector wise break-up of gross NPLs shows that the contribution from the corporate sector in gross NPLs growth remained at 5.8 per cent during IHFY10. This was much lower than the corresponding period of 1HFY09. While, the distribution shows a large number of borrowers in the agricultural sector, the value of NPLs is concentrated in the corporate sector. As a result, the average size of corporate sector NPLs stood at Rs78.3 billion by end December 2009. This suggests that a small number of large borrowers have the potential to cause significant deterioration in asset quality of the banks.
In the corporate sector, textile, sugar and cement are the main sectors contributing to the increase in gross NPLs during 1HFY10. The rise in textile sector NPLs seems quite surprising given the recent increase in external demand coupled with better cotton crops. One of the possible explanations is the operational bottlenecks that the textile sector has been facing in last few years. These mainly include extended gas and power outages and a recent sharp depreciation of rupee against US dollar which has made foreign currency borrowing more expensive for a few corporate sectors.
All these factors hampered the repayment ability of a few borrowers.
In brief, the economic outlook is mixed. While inflation decelerated significantly during FY10 compared with the preceding year, inflationary pressures have decisively remerged in recent months. Similarly, although, the current account deficit witnessed improvement, sustaining it at low levels will be challenging given rising import requirements of the economy, and evident weakness in the pace of growth in remittances. Prospects for real GDP growth are better relative to the preceding year. However, this level of growth is not adequate to generate required employment opportunities.
This situation reinforces the need for serious policy efforts to achieve sustained high growth. This needs both macroeconomic stability (low inflation, prudent fiscal stance, low current account deficit, high investment and savings), and political stability, including improvement in law & order and security conditions. Implementation of structural reforms focused on elimination of subsidies, reduced role of government in price setting, formulation of effective regulations to ensure optimum market-based outcome, are needed to sustain growth and enhance resilience of the economy. These must also be complemented with the introduction of second generation reforms centered on institution building and governance.
It is worth reiterating that while tax reforms are most readily legislated during times of economic stress, this is also the period where the revenue impact of reforms is most limited. In other words, revenue measures will gain most traction only when the economy recovers. This implies that, in the short run, there may be few options to contain the fiscal deficit. Nonetheless, aggressive fiscal reforms are key to achieving and retaining macroeconomic stability in the medium term. These need to focus on the entire range of options from increasing efficiency of public expenditures, reducing size of government, raising the tax to GDP ratio.
The government intervention cannot successfully stabilize the economy and simultaneously provide stimulus for growth. This means that fiscal policy must be carefully calibrated and prioritized by targeting either the provision of public goods or targeting market failures, and also create an enabling environment for provision of other services by the private sector. In this context, the government intervention in market pricing is likely to create distortions. These can not only lead to inefficient production decisions, and entail very significant fiscal costs. The added political risk in market pricing can discourage private sector investments.
It will be extremely challenging to sustain the growth recorded in Jul-Jan FY10 given the prevalent energy shortages in the country. In addition to energy insufficiency, local manufacturers are also confronting the rising cost pressures, since electricity and gas tariffs have been increased persistently. Furthermore, the rise in global commodity prices can also put significant pressures on production costs.
Finance and insurance sub-sector is likely to rebound following the recovery in loan demand from private sector. Initial financial reports of few banks for 1HFY10 show an improvement in earnings attributed to increase in volumetric expansions coupled with widening margins. However, a part of earnings growth will be offset by higher provisioning.