Apr 23 - 29, 20

Pakistani stocks on April 16 tumbled, as investors went for profit taking in banking stocks owing to the central bank's decision of raising minimum rate of return on banks' saving accounts. The State Bank of Pakistan (SBP) raised minimum profit rate on saving products by one percent to six percent per annum in a surprise move to encourage depositors, as it announced its monetary policy on April 13 for the next two months.

The increase in the minimum interest rate will be applicable from May 1. Critics however say that the central bank's decision is against free-market practices and it may affect earnings of larger banks. The benchmark Karachi Stock Exchange (KSE) 100-share index on April 16, the first trading day of the last week, fell 0.2 percent, or 28.72 points closing at 13,770.70.

The analysts argue that the banking sector's concerns over sudden rise in minimum rate of return on banks' saving accounts actually hit the banking stocks causing an overall decline in the KSE 100-share index.

The National Bank of Pakistan (NBP) fell 3.5 percent to close at 46.30 rupees, Bank Al Falah closed 2.1 percent lower at 15.75 rupees, and NIB Bank witnessed a decline of 4.5 percent to close lower at 2.55 rupees.

The central bank in its monetary policy said that a more balanced risk-reward incentive structure is warranted in the shape of appropriate deposit rate structure, as savers, especially smaller ones, need to be adequately compensated.

"This move will have a significant impact on banks' profitability, as savings deposits account for nearly 38 percent of all bank deposits, and 52 percent of the total number of deposit accounts," Reuters reported Sayem Ali, economist at Standard Chartered Bank as saying.

Savings accounts constitute about 38 per cent of the total deposits in the country's banking system. National Bank of Pakistan, Habib Bank Limited (HBL), Muslim commercial Bank (MCB) and United Bank Limited (UBL) are the country's largest banks in terms of assets.

Some local market analysts believe that the country's big four banks could witness a reduction in their net profits by seven to 11 percent after increase in minimum profit rate on saving products.

The increase in minimum returns on savings could increase lending rates, as it would cost billions of rupees each year to banks. Some analysts estimate an additional cost of Rs17 billion a year to banks assuming the deposit structure to remain the same and banks will not pass on the impact.

The central bank first intervened in May 2008 and imposed the minimum rate at five percent. Before 2008, the depositors were not enjoying the high interest rates, as the average savings account yielded only two percent.

The central bank left its discount rate unchanged at 12 percent amid worries about double-digit inflation and the government's continued reliance on heavy borrowing from the banking sector.

Analysts believe that fears of higher inflation mainly because of government's excessive borrowing from banking system forced the central bank to leave its benchmark interest rate unchanged.

Consumers Price Index (CPI) inflation in the country hit 10.8 percent in March, while core inflation has witnessed a steady rise since August 2011.

In its monetary policy statement, the central bank said the external sector is likely to remain under pressure because of both external debt payments and a lack of foreign aid. The country's current account deficit widened to $2.95 billion in the first eight months of the 2011/12 fiscal year, compared with $194 million over the same period the previous year. Local analysts forecast that the deficit may widen to $4.6 billion or two percent of GDP, with higher debt payments adding to pressure on the rupee, which is forecast to depreciate further to Rs92 for the US dollar by June and 96 by December 2012.

Inflation-fuelling government borrowing from the central bank surged by 161 percent to Rs294 billion by March 30, 2012 when compared with Rs112.67 billion as on April 2, 2011.

The central bank has time and again raised the issue of excessive government borrowing banking system. Federal government has betrayed its commitment to keep borrowing from the central bank at zero level on quarterly basis as its borrowing increased from the central bank by end of third quarter of the current fiscal year ending June 30.

The net borrowing from the central bank for budgetary support was at Rs217 billion by March 30, which was Rs9.75 billion on April 02, 2011. It seems challenging for the government to contain the overall fiscal deficit to its revised target of 4.7 percent of GDP in the current fiscal year ending June 30.

The government is involved in higher borrowing from scheduled banks than the central bank, which injects money at around 12 per cent through open market operations, while the government borrows the same at higher interest rates from large banks, whose profits rose by 27 per cent last year.

The government borrowed Rs679.445 billion from scheduled banks during July to March 2, 2012 compared with Rs277.488 billion in the same period of last fiscal year, showing an increase of Rs402 billion.

The government's failure to get the required external inflows to finance its swelling budget deficit has made it a desperate borrower, relying heavily on banking system.

Critics say that the government's increased reliance on domestic borrowing is highly inflationary, as it is not backed by an increase in productivity. The government has so far relied exclusively on decreasing development expenditures while raising non-development expenditure.

It seems challenging for the government to contain the overall fiscal deficit to its revised target of 4.7 percent of GDP in the current fiscal year. The country's widening budget deficit, which has been projected by IMF to reach seven percent of GDP in the current fiscal year, is likely to force the government to borrow more money from the banking system or print more money to finance its fiscal deficit.

The Asian Development Bank (ADB) has forecast that the government would miss its 4.7 per cent revised budget deficit target in the current fiscal year. The Manila-based ADB in its latest report said, "The economy continues to be affected by structural problems, including the energy crisis, a precipitous decline in investment, persistently high inflation, and security issues. Budget deficits remain high, driven by substantial subsidies and losses at state-owned enterprises, and tax revenue below target."