Restore macroeconomic stability to revive private sector credit

Since the 2008 economic crisis, the private sector’s contribution to economic growth has been marginal, replaced in large part public sector projects and CPEC (China Pakistan Economic Corridor).

This has placed an already flawed economic model on a completely unsustainable trajectory, while also failing to spur growth, control inflation or generate employment.

The numbers are stark. Private credit-to-GDP stood at a mere 10 percent in FY24, one of the lowest globally.

This is a significant decline from its peak of 23 percent in FY07. For a perspective, World Bank data shows private sector credit-to-GDP at 12 percent in Pakistan compared to 29 percent in Egypt, 37 percent in Bangladesh, and 50 percent in India.

Credit to private sector in Pakistan is negligible, presenting a prime opportunity to reignite economic growth using a private sector led model.

In 2000, private credit-to-GDP fell to 14 percent. However, subsequent government debt restructuring, deregulation of finance, telecom, and oil & gas sectors spurred private credit growth, making it a key economic driver.

Billion-dollar private sector projects emerged, including two large fertilizer plants and massive telecom investments.

The privatized banking sector revitalized growth, and even IPPs (independent power producers) attracted local investment.

The 2008 crisis reversed this trend. Bad loans surged as banks struggled to recover debts, hindered by a court system favoring defaulters.

Reluctant to lend, banks shifted focus to lucrative government lending. The incentive to support the private sector vanished.

Since 2008, successive governments have relied heavily on public investment, fueled by the 7th NFC award. However, public spending efficiency is low due to poor governance and competence. CPEC projects while initially spurred growth are now burdened by high costs.

This fiscal unsustainability and energy sector crisis have forced the government to rely on domestic banks, crowding out private sector lending. High energy costs and interest rates are now forcing private sector deleveraging.

Revitalizing private credit is crucial. Underutilized capacity presents a growth opportunity, but filling this gap requires reduced interest rates, lower energy costs, and macroeconomic stability. To stimulate new investments, political stability, fiscal discipline, and rationalized taxation are essential. Excessively high tax rates are driving businesses and talent out of Pakistan.

Unleveraged private sector implies that there is slack available which can potentially become the engine of growth. However, right now there is massive, underutilized capacity in many sectors.

First that must be filled, and for that the appetite for working capital must first grow – which cannot happen without lowering interest rates, lowering energy costs, and cementing macroeconomic stability.

Once that is addressed, the next step is to invest in new projects. For that to happen, some semblance of political stability is required and more importantly, the fiscal house must be brought to order.

Taxation must be rationalized. Tax rates for employers and employees in private sector have become punitively high and no one is willing to invest. Everyone is thinking of leaving.

The businesses find higher post tax return outside, while skilled labor and executives are searching for low tax regions such as the UAE. Without lowering the tax rates, investment is hard to come by.

Ultimately, the private sector holds untapped potential for investment and growth. Spurring private credit is key to reviving the economy and creating jobs.

Copyright Business Recorder, 2024