In an earlier article "The real corridors of prosperity" carried by Business Recorder on October 20, 2016 I had dilated on the potential pathways for attaining prosperity for the people of Pakistan. Among the many ingredients for success the financial sector's role of generating investment in the economy is critical. In this respect I had said that,
"The banking industry is the most developed part of the financial sector of the country but the government still expropriates around sixty percent bank credit of the country. The Government also hogs almost all foreign and domestic borrowings from the global and local capital markets.
Foreign direct investment which has dramatically transformed many countries is still very anemic and strategies to be a major destination of foreign investment have not succeeded. Foreign investment in the power sector is becoming a story of greed and scam.
The equity markets are underdeveloped in Pakistan with very few primary offerings in the market place. Lack of Investment Banking activities, Venture capital, Pension funds and access to crowd financing in Pakistan hampers the private corporate sector to become the engine of growth in Pakistan. Personal savings, money laundering, overseas Pakistanis through their remittances are a major source of capital coming into Pakistan this capital primarily fuels the informal sector.
Overall, it is eminently possible that the currently under developed financial sector can be turned around to become the major corridor of prosperity for us."
Critical state institutions like the State Bank of Pakistan (SBP), the Securities and Exchange Commission of Pakistan (SECP) and the Board of Investment (BoI) are primarily tasked with the overall responsibility of ensuring that financial resources are fully harnessed for national development and prosperity. While SBP and SECP deal with promoting the effectiveness of the domestic financial and capital markets of the country BoI deals with promoting foreign direct investment (FDI) in the country. Of course the Ministry of Finance bears the overall responsibility for unleashing growth and prosperity.
In a market economy like ours, these institutions ensure that sufficient national savings are channelled through appropriate institutional arrangements into the most productive sectors of the economy. The BoI's efforts are geared towards augmenting the flow of national savings with foreign savings to amplify the investment in the country in the shape of FDI. The investment to GDP ratio and FDI to GDP ratio are thus important macro indicators of success for these institutions.
Overall, the investment to GDP ratio that achieved a peak of 23.5 % in 2006-07 dropped to a low of 13% in 2010-11 and has now reached a level of 15% in 2015-16. At current GDP, a ten percent drop in the ratio reflects a loss of $30 billion in investment in a year. FDI which had reached a level of over $5 billion in 2006-07, has since seldom crossed the one billion dollars mark. With the advent of the CPEC hopefully this would change. This prolonged drought of investment in the economy has taken a toll on the overall growth of the economy, employment generation and associated poverty levels in the country.
The role of the banking sector has been dismal. Since 2008-09 in seven years the banking sector has created almost Rs 6.44 trillion of banking credit and the government has taken the lion's share of 79% of it; leaving only 21% for the private sector. Truly crowding out the private sector from the credit market. Knowing that the government is not known for its efficacy in spending for development a large proportion of a very scarce national resource has been squandered.
Over this period, out of a yearly average of Rs 921 billion of credit creation the private sector's yearly credit uptake has only been Rs 197 billion. In contrast, in the period 2004-08, the average credit creation per year was Rs 531 billion and the private sector took a cool 75% with almost Rs 400 billion per year. This partially explains the high growth rate of the economy during that time.
Imagine that post-2007-08 if the private sector had not been crowded out and had continued at the old pace its credit offtake would have been an additional Rs 3.5 trillion along with associated self financing and sucking in of foreign investment.The overall Investment to GDP ratio would not have collapsed and would have continued at around twenty five percent of GDP instead of the current 15%. Bad national economic policies, bad economic management and deteriorating law and order have been largely responsible for this debacle.
In the modern banking literature the raison d'etre for the existence of the enormous global banking industry is its ability to overcome the problems created in the relationship between lender and borrower due to the inherent asymmetric information and moral hazard between them. In simple English it means that banks can make better investment decisions compared to bank depositors, since banks can employ superior information gathering, superior analysis and effective organisational structures to make better investment decisions and effectively monitor the behaviour of borrowing entities.
In the case of Pakistan, for almost the last decade the banking system has abdicated this role of the financial intermediator and has instead succumbed to the vociferous appetite of the broken government financial system. This was done in partnership with the central bank and the IMF. If vast amounts of bank credit are going to be earmarked for the government then what is the need for the huge and expensive organisations of the banks' risk and credit setups.
Banks seem to be comfortable with the situation because given the recent bad experience of the huge non-performing loans portfolios. These were accumulated due to market risks, bad government policies, poor credit and risk decisions along with poor loan monitoring. The losses have shaped the banking industry mindset. It seems that the top management of banks are satisfied to do riskless lending to the government at high rates with sovereign guarantees and enjoy quality of life at the golf course.
Furthermore, the banking sector's lending has not been able to effectively cover the entire spectrum of the economy ranging from the small and medium enterprises, agriculture, construction, housing, transport, logistics, wholesale, retail, health and education sectors. The SBP needs to develop a comprehensive strategy to correct the situation if the banking sector has to play its role in the national development.
As far as the non-bank financial institutions and capital markets are concerned their impact on national development has been marginal at best. The lack of a corporate debt market, the lack of a vibrant private pension funds industry, the full range of insurance saving products and coverage, the lack of a private equity industry, the paucity of take-over and merger activity, the lack of new listings, the absence of venture capital institutions amongst others are a glaring failure of SECP's development role. In contrast to its regulatory zealousness, its task is to fully functionalize the non-bank investment channels of the economy. All have a huge potential but realising the full potential has been an uphill battle.
The Third stream of investment flow that is critically important is of course the FDI channel. Pakistan continues to be a difficult country to invest in. The information sources are few, regulatory burden is heavy and the red tape is pervasive. It is the role of the BoI not only to market the country as an investment destination but also to help deregulate the investment value chain so that the foreign investor is not tied up in knots by the bureaucracy. The so-called single window operation has to be made effective. It has now a great opportunity to use the CPEC to attract non-Chinese FDI as well. FDI is a non-debt foreign capital flow and in its absence the government has to depend on debt flows that compromise the country's debt sustainability.
If the country has to achieve its full potential of growth and it has to harness the growth opportunities for the welfare and prosperity of the people of Pakistan then it has to boost its investment performance substantially. The government needs to set an investment target of 25 percent of GDP by 2018 to generate the growth needed for winning the next elections. For this to happen, the government has to fully unclog all the investment channels of Pakistan.
(The writer is a former Finance Minister)
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