Provisions against bad loans in the banking sector are still growing, but at a slower pace. But what does it tell? Let's take a quick peek into recent economic history, before answering that. Right after foreign exchange reserves reversed from its upward trajectory in the second quarter fiscal year 2007, bad debts in the banking system started rising.
Although, the stock market, and other leading indicators that respond to shifts in the economy beforehand, remained resilient till the second quarter of 2008, the poor performance of corporate sector was visible long before. This means it can be safely implied that the quality of balance sheet of commercial banks is one of the best indicators of the health of economy at large. With a 16 percent decline in foreign exchange reserves between January-March 2008, the sector's non-performing loans had grown by a whopping 27 percent.
Now, since the start of this calendar year, the short to medium terms macroeconomic indicators are improving, thanks to IMF's rescue package; the growth in bad loans, which hovered around 12 percent in the last quarter CY08, has been on a consistent decline, down to 6 percent in quarter ended last month.
Going forward, within the phase of stabilisation Pakistan is currently in, fundamentals of the export oriented textile and allied industries are likely to improve further on the back of the spillover impact of stimulus-led global recovery. A growth in textile and allied businesses - an industry most infectious with high concentration of NPL - means that the quantum and frequency of bad loans will decline.
Thus, it can be assumed that the pace of growth in NPL's will slow down in the coming quarters. This can also be construed on the basis that IMF forecasts money supply to grow by 9.6 percent in coming three quarters of this fiscal year. Hence, there is a fair chance in the reversal of credit to private sector, which might emanate from foreign flows in different forms.
This bodes well for economy at large and commercial banks in particular. There is a good possibility of banks to revert to commercial and industrial lending. However, the growth might not be exuberant owing to rising needs of government to finance its fiscal shortcomings through domestic sources.
That, however, doesn't mop up the doubts over the medium to long term outlook of the banking sector and the economy at large. With talks abound on the W-shape global recession in the international economics establishment - the monetary and fiscal stimulus with sticky global supply is creating an asset bubble. If their fears come to life, one might see a reversal in this stabilisation process. When, what will happen, it's too hard to say.
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