“Concessionary financing rates are theoretically linked to the policy rate. While a four-percentage point differential may appear acceptable under the current monetary environment when Kibor is at a multi-year low, sooner or later SBP may begin to reverse the tide of monetary expansion. When (and not if) that happens, EFS lending rates will inadvertently move up as well. Will textile exports be able to maintain their momentum once the central bank reverses gears?” (from “Textile: is SBP footing the bill for export growth”, published in this section on August 13, 2021“.)
Rarely does a forecast come true with such precision. Over the past 18 months, banking credit to textile and apparel industries has plunged by over one-third in dollar terms, with a matching decline in monthly exports by the sector. The historic climb in the policy rate has naturally pushed the brakes on credit offtake to the industry, which rose by only 8 percent over the last 12 months in nominal Rupee terms, at a time when average inflation is fast approaching 35 percent and currency has depreciated by over 50 percent. If the liquidity squeeze continues for another year, will the exporting segment be able to withstand the pounding by the interest rates?
Although unscrewing the cork of monetary squeeze might seem like the obvious answer to enable export growth in the near term, perhaps a lesson in recent history is warranted. The current liquidity squeeze facing the textile and garments industry follows a decade of historic debt build up by the industry, built on the now-dead corpse of concessionary finance bonanza. Between 2012 and 2022, industry’s share in total credit to private sector businesses remained largely static at 25 percent (and 16 percent of net advances by the scheduled banks). During the same period, however, the pricing profile of credit to the industry transformed irreversably, with share of concessionary finance rising from 20 to 45 percent of total loans to the industry, (while industry’s share in total concessionary loans extended to private sector rose from 55 to 70 percent).
Textile industry debt binge was made possible by a 2016 decision by the central bank to de-couple loans extended on subsidized mark up rates from changes in the policy rate, and peg refinance rate at 2 percent (plus bank’s spread). Naturally, because working capital requirement of exporting industries is linked with the value of currency, subsequent rounds of currency depreciation (such as in 2018-19) justified the need to scale up the size of concessionary loan limits for textile, which rose from Rs250 billion in early 2017 to Rs450 billion by late 2019, even before the pandemic hit the economy forcing the central bank to roll out the red carpet of TERF – the motherload of cheap debt bonanza. TERF was supposed to raise the investment levels in the manufacturing segment at large, leading to an overall rise in industrial capacity and productivity across all economic sectors. However, as this section has highlighted many times in the past, not only were the TERF loans largely utilized by the exporting industries – which were already availing of other refinance schemes such as LTFF and EFS – it need not offer the necessary boost to capacity or productivity as had been claimed at the time. In fact, three years since TERF’s roll out, the screeching halt in working capital loans offtake (even in nominal rupee terms) indicates that capacity utilization and industrial output levels have not risen, raising questions on the wisdom of the scheme.
But TERF had one unintended consequence, which (hopefully) would serve the beneficiary of the schemes well even if industrial output fails to gear up in the coming years. Because TERF loans were extended for fixed investment/capex, these were long term loans extended at fixed pricing ranging between 3 to 7 percent per annum on average (inclusive of banks’ spread) for up to 7- 10 years tenor. This means that when the monetary squeeze hit the proverbial fan over the last year, pricing on LT concessionary finance such as TERF remained unchanged, ensuring that the debt servicing cost or interest expense of borrowing firms would stay under control.
Not so much for the borrowers of working capital facilities such as Export Refinance (EFS). By early 2022, when the central bank leadership realized that the ‘gradual and measured’ tinkering of the policy rate would not pay dividends, it finally pulled the carpet from under the EFS borrowers, once again linking the refinance rate with Kibor (minus three percentage points). All of a sudden, textile and garments exporters – which over the last decade had become addicted to virtually risk-free borrowing – were forced to pay mark up rates 15 percentage points higher on their outstanding EFS loans, than what they had been just one year earlier.
Linking the EFS rate with Kibor at a time when policy rate has broke through its historic ceiling seems to be SBP’s roundabout way of putting the concessionary lending out of fashion permanently. In fact, if textile’s addiction to concessionary finance is to be broken, SBP must put its newly gained autonomy to good use and stand steadfast in the face of any pressure from Q-block to enhance EFS limits in future.
But the gambit to wind down the concessionary lending portfolio could just as well kill few textile firms in the process. Look closely at the infographics, and you may discover that few mid-sized banks have up to 40 percent of their net advances concentrated into loans to textile, where export refinance (EFS) loans constitute a dominant share. Not all firms across the textile and garments industry might be able to handle a 15 percentage point escalation in debt servicing for extended periods, especially those who for years have been addicted to servicing their debt at under 5 percent per annum markup rate. Some might even go under.
The million dollar question then will be: what shall happen to the banks facing a significant concentration risk of EFS loans made to industry?
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