During the post MPC briefing by the SBP earlier this week, the central bank governor noted that the full transmission of earlier rounds of monetary tightening is yet to fully reflect in private sector credit. The statement was factual. The markup rate on outstanding private sector loans is usually reset every calendar quarter, thus the impact of the 200bps increase in policy rate during Q4-FY23 is yet to be reflected in private sector credit figures. However, over a longer run, private sector credit growth has been receding, signaling a secular decline in the size of formal sector of the economy.
That private sector credit has turned negative in real terms would probably not be news to most informed readers. Since 2018, the annual inflation rate has averaged above 13 percent. Meanwhile, private sector credit growth has averaged close to 9 percent during the same 5-year period, indicating a decline in real terms. However, even a cursory analysis of private sector credit datasets published by the central bank periodically shows that the decline in real terms has been both significantly more precipitous and substantive. In the following analysis, BR Research has rebased nominal value of outstanding private sector credit using monthly price index (N-CPI) to arrive at credit growth in real terms, with base period set as at fiscal year 2015-16.
The analysis reveals a shocking decline of almost one-third in aggregate stock of private sector credit since its peak in January 2019 (to date). The downward trajectory is particularly fascinating considering that the stock of private sector credit shrank at a time when the applicable borrowing rate (Kibor) during 42 out of the last 54 months was under the average inflation rate during the same period; meaning the benchmark rate was negative.
This effectively means that the prices across the economy were increasing at a higher rate than the rate at which working capital or fixed investment could be financed by accessing banking credit at commercial terms. This does not even take into account the actual borrowing rate for many firms, aseffective debt servicing cost in many cases would be averaged out due to concessional loans(especially for export-oriented firms). Yet, private sector growth in real terms has been observing a conspicuous contraction for much of the past 4.5 years, with the run rate gaining strength in tail-end months due to the historic rise in policy rate during the last fiscal year.
Although zooming in further on the contraction in private sector credit makes for an even more fascinating study, many of these infographics are self-explanatory. What stands out, however, is the big picture implication. Private sector credit is often used as a proxy for real growth in the formal sectors of the economy, as liquidity from the banking sector sustain both, working capital requirement of the business, and the investment in fixed assets required for expansion and productivity enhancement tools (i.e., technology and efficiency).
However, the fact that private sector credit – across almost all segments except concessional LT debt and export refinance loans –remained below their 2018-19 peak levels, despite the Covid-era monetary bonanza, indicates that much of the growth in private sector business turnover may have been primarily price-driven in nature, with industrial volume (or utilization levels) still below their 2018-19 peak. This is a scary realization, especially considering that the economy recorded over 5 percent real GDP growth during two out of the four fiscal years in this period.
In addition, consider also the rise in speculative activity in the economy over the last four years targeting the commodities sectors, especially since the implementation of market-based exchange rate. A contraction in private sector credit during the same period (in real terms) may also indicate that most of the rise in speculative behavior in the economy during this period has been cash-driven, with little to no contribution from banking sector liquidity, even during the days of loose monetary policy. This may be a good sign, except of course the corresponding implication that a greater share of economic activity today may be taking place out of formal sector than 4.5 years ago.
Which leaves us with the million dollar question: if private sector credit has witnessed negative growth over the last several years – even though the GDP has recorded more than modest growth during the same period - does that mean that the formal economy is in fact shrinking?
Methodology: The infographics depict private sector credit outstanding stock in real terms.The author has used the nominal value of outstanding monthly stock of private sector credit by type of finance as reported by SBP and divided it by monthly Headline National CPI Index value as reported by PBS. The time series goes back only up to July 2016 to ensure consistency with rebased CPI (new base period, 2015-2016). A work by Adil Mansoor for BR Research.
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