For the last few years, financial institutions have been very comfortable in lending to the public sector through rapid increase in the holdings of government securities; and they shy away from extending credit to the private sector. However, the growth in private sector credit has been particularly muted this year. Obviously, if private sector in Pakistan remains dormant, for whatever reasons, foreign investors would also avoid the country. Although foreign investment was reported to be higher by 47 percent during the first four months of the current fiscal, it was limited to only dollar 423 million, reflecting a disappointing attitude of the foreign investors. Such a low level of investment was of course much less than the absorptive capacity of the country and compared very unfavourably with most of the other countries in the region.
An abysmally low level of private sector credit off-take could be attributed to a number of factors both on the demand and supply side. Entrepreneurs in the private sector are fed up with unending shortages of electricity and gas, a deteriorating law and order situation, policy uncertainty, corruption and harassment, crumbling infrastructure, etc. A peep into the lives of local entrepreneurs and their travails in Pakistan can be had through a cursory look at Sadruddin Hashwani's book "Truth Always Prevails" and the writer's subsequent interviews.
On the supply side, government's increasing reliance on the banking system for financing its budget requirements has crowded out the private sector as banks now prefer investment in government securities which are high yielding and risk-free at the same time. The banks' behaviour is understandable. Why would they invest in risky ventures at a rate of about 14 percent when the cut-off yield in the auction held on 22nd October, 2014 was 12.48 percent for three-year PIBs, 12.97 percent for five-year PIBs and 13.47 percent for 10-year PIBs. The most traded bond was three-year PIBs which offered a very reasonable rate of return and also provided an opportunity to lock funds only on a short-term basis. The State Bank has been advising banks on various fora to play their intermediary role between savers and investors properly and more seriously but only moral suasion does not work when opportunities for making more money without much effort are easily available. Although the cut-off yield on PIBs was considerably reduced in the auction on 19th November, 2014, but its impact on banks' behaviour cannot be exactly anticipated at the moment.
There is absolutely no doubt that such a situation needs to be changed for improving the growth prospects of country's economy. The present growth rate of around 4 percent per annum is definitely insufficient to reduce unemployment, and reduce poverty thereby improving the living standards of ordinary households, especially when the population growth rate of the country is still around 2 percent. The government and the opposition parties must work together to remove the impediments to investment, both domestic and foreign, so that private sector seeks more credit from banks with greater confidence and by offering competitive rates. Once banks are convinced about the solvency and credit repayment capacity of the private sector, they would be tempted to lend more to entrepreneurs. Of course, some of the businesses would still go under, just like other countries, but the overall percentage of such undertakings would be manageable. On the other hand, government must reduce fiscal deficit, try to finance it from non-banking sources and manage its debt portfolio in a way so that banks don't find it too profitable to invest in government securities. In fact, a proper balance between the rate of return on government paper and private sector investment, adjusted for the pros and cons of placing funds in the two sectors, would be preferable. Such a balance would give an edge to banks which are more innovative and would work harder to expand their businesses professionally in a competitive environment. Overall, the present trend in bank credit is neither conducive to the health of the economy nor very much in sync with traditional banking behaviour. The latest 50 basis points reduction in the policy rate by the State Bank and the likelihood of a further drop in the coming months is of course welcome for changing the trend but how it pans out in the long-run could only be seen in the coming months. This is so because insensitively of government borrowings to interest rate changes could blunt the effectiveness of monetary policy to a certain extent.
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