Refinancing under old terms

The State Bank of Pakistan seems to have finally wilted under pressure. In a surprise move, it allowed banks/DFIs on 2nd October, 2007 to extend refinancing facilities under the terms as applicable to the now defunct Long-Term Financing of the Export-Oriented Projects (LTF-EOP) scheme in respect of letters of credit (LCs) established for import of plant and machinery for export-oriented projects on or before June 30, 2007.
The initiative to provide refinancing facilities under the old scheme is reported to have been taken in order to meet the needs of the textile industry. In the wake of the latest move, the SBP said, a substantial amount was expected to be released by the central bank as another gesture of support to the textile sector.
The SBP's LTF-EOP scheme, it may be recalled, was introduced during 2004 to provide medium-to-long term capital financing for export-oriented projects at subsidised rates to enable them to import plant and machinery for setting up new units or for balancing, modernisation and replacement (BMR) of existing projects. Under this scheme, the State Bank provided long-term financing of around Rs 50 billion, including debt swap of Rs 34 billion, during 2006-07 to sponsors of export-oriented projects in the textile sector through banks/DFIs at rates of six and seven percent.
However, the State Bank, stopped financing under the LTF-EOP scheme after June 30, 2007 and no new limits for 2007-08 were sanctioned to the banks/DFIs. Instead, a new scheme, namely, Long-Term Financing Facility (LTFF) was proposed to be introduced and a draft of the detailed policy parameters was sent to the stakeholders for feedback.
How much money is going to be disbursed by the State Bank after last week's policy reversal is not exactly known, but, according to some sources, the additional amount needed to finance the LCs opened prior to June 30, 2007 could be several billion rupees. What, however, is clear is that the decision was taken by the State Bank under pressure and the textile industry, being the largest sector of the economy, has been able to persuade the government to get the maximum benefit of the substantial interest rate subsidy under LTF-EOP. The representatives of the textile sector were of the view that their demand was genuine and the authorities must support the sector in order to enhance its export potential.
However, the State Bank had argued that the refinance scheme had been grossly misused, which led to other distortions. In its latest Monetary Policy Statement (MPS), the State Bank had observed that "another major aberration in FY07 emanated from the high level of SBP refinancing extended for both working capital and long-term investment to exporters. Aside from monetary management complexities, these schemes are now distorting the incentive structure in industry".
The State Bank had also emphasised the need for adopting a more balanced approach with regard to refinance operations which often diluted the central bank's monetary stance and were a principal source of reserve money growth. It was also decided to gradually reduce commercial banks' reliance on refinancing facilities and encourage them to mobilise the desired level of resources to fully accommodate private sector's export credit requirements. Clearly, the latest decision of the State Bank is against its declared policy strategy as enunciated in the MPS which, in our view, was quite logical and made a lot of economic sense.
The injection of billions of rupees in the system, besides creating distortions, would also contribute to growth in liquidity in the economy and fuel inflation. The sudden shift in policy could also send a wrong signal to the other sectors that the State Bank is amenable to pressure and undue advantage could be gained by employing the right tactics. The State Bank could, however, defend its decision by saying that it has only relinked the utilisation of old facility with the date of opening of LCs which is not a major departure from its basic refinancing policy.
But it needs to be realised that its latest announcement has encouraged a situation which it wanted to discourage and against which it had argued for good reasons. Another sad aspect is that businessmen of this country are still looking for crutches and find themselves unable to compete in the international market without some kind of support by the government.