Watch out banks ratings!

The horrendous series of financial crises confronting the world today is, arguably brought on by the slicing and dicing of ballooning debt by smart investment bankers. While the world scrambles to learn lessons from the current conundrum; in Pakistan investment bankers and stockbrokers are rising to the helm of regulatory bodies. Optimists would assert that these industry professionals are the doers and not the dreamers. But to those among us, who see the whole glass half empty and half full, it is equally obvious that such appointments would wreak lack of prudence. When the proposed (temporary) fix to the inter-corporate debt in the energy chain is viewed in this context, it appears that the pack of investment bankers and brokers are wielding more influence on the finance ministry than ever before. The deal of converting debt from the energy sector and commodity operations in to sovereign paper is sealed. This allows banks to book these assets as investments which creates room for them to extend fresh credit to power and agriculture sectors. TFCs and wheat procurement operations are both typically conducted at about 200 bps above KIBOR. So the latest arrangement lets the government lower its debt servicing cost marginally by Rs.8-10 billion a year. Besides, the deal also improves the Pakistans prospects for receiving $2 billion in new loans from the World Bank and Asian Development Bank. That said any further helpings from these multilateral lenders will be largely contingent on IMFs nod. But, whether or not, this arrangement actually has a significant impact on the relative risk to the energy sector-it is a completely different debate. But for now, it is clear that the banks are doing little besides taking peoples savings to lend back to the government. Given that these funds are mostly channeled for defense spending, debt servicing, blanket subsidies and, of course, to keep alive the white elephants (PSEs); it is clear that there is not much growth being generated through this cycle. So what is the big deal with using savers money to plug the gaping circular debt? Optics matter! In accordance with SBP prudent regulations and banks internal limits, this paves way for banks to lend more to power sector especially to IPPs and other energy channels. But governments bullying tactics against banks venturing into any avenue other than one that leads to the governments never-ending hunger for credit, leaves limited scope for funding of such emerging and potentially beneficial projects. What may raise eyebrows of SBP while doing its CAMELS rating or other national or international rating agencies is banks exposure to government paper! As of August 30, 2011, the ratio of the banking sectors holdings of government paper against deposits stood at 41 percent, compared to 28 percent about two years back. The conversion of Rs.391 billion increased the ratio of banks holdings of government securities to total deposits by another 7 percent to 48 percent. Excessive lending to any sector is always unsustainable; even if the sector happens to be the government. This is especially true for a government that has run a fiscal deficit in excess of 6 percent consistently over the past few years. Moreover, this conversion is expected to take this yawning deficit to a bleaker 8 percent of GDP in FY12. The issue, dear readers, is that this conversion of energy sector and quasi-fiscal debt is little more than an optical illusion. Negative cash flows to the tune of Rs.15-16 billion per month will, in all likelihood, continue to haunt the government. The actual resolution to this mess lies in addressing the inefficiencies in the production, transmission and distribution of power. Sadly, the much-touted fix is silent on this front.