Bank credit: go, went, gone?

Credit to private sector businesses by the banking sector is down 66 percent year-on-year in the first nine months of current fiscal year. The story of what happened isn’t new. But the story of what happens in the months ahead is something that needs to be prepared for.

Here’s what has happened in 9MFY20. Credit demand from private sector businesses was poor because of poor performance by manufacturing sector, to which about 60-62 percent of total bank credit is historically allocated. Contraction in imports also led to lower credit needs.

If the Large-Scale Manufacturing index is any guide, the country’s manufacturing sector has been on a recession for as much as six quarters, and from the looks of it, growth will be elusive in the next quarter as well. (See BR Research’s ‘Manufacturing recession: five quarters and counting’ & ‘LSM: brace for impact’, published Jan 21 & Apr 21, 2020)

The central bank’s data for bank loans classified by type-of-finance shows that loans for fixed investment or long-term loans eased by 0.2 percent year-on-year in 9MFY20, whereas working capital & short-term loans barely grew at 1.3 percent. Among major types of loans, it was only export refinancing loans that grew a decent 30 percent during 9MFY20, but because export refinancing is only 11 percent of total outstanding loans, it could not move the needle for private sector credit.

Unsurprisingly, borrowing by the SMEs has taken the most hit. If loans by SMEs were 9.3 percent of total bank advances at the end of FY19; by March 2020 that number shrank to 8.2 percent. Poor economic growth, high inflation and high interest rates squeezed the repayment capacity of many companies across several sectors such as steel, auto parts and electric goods, where, according to SBP’s recent State of Economy report, financing expenses had even touched 80 percent of firms’ gross profit margins by end of 1QFY20.

This is precisely why non-performing loans have started inching up. As per the central bank’s last financial soundness indicators, the ratio of non-performing loans to total loans grew to 8.6 percent by the end of 2QFY20 from 8 percent at the end of same period last year. Bear in mind the NPLs had been consistently dropping since December 2011 when it stood at 15.7 percent; and it has risen for the first time in many years.

But this is all post-mortem analyses. What lies ahead should be a matter of concern. If forecasts and expectations by the IMF and others are right - that a greater than the Great Recession is on the cards - then expect NPLs to rise substantially, and growth in credit off-take to remain damp.

The former may take a bit longer to hit considering that the central bank has relaxed repayments on account of the pandemic, but in face of poor economic growth, NPLs should be expected to rise.

Similarly, while there may be some growth in credit offtake, courtesy new softer loan packages announced by the central bank to help firms in covid management, it is unlikely to offset the impact of no major capacity expansion on the horizon, a hit on exports, and lower commodity prices which in turn leads to lower working capital needs. That said, some sections of economy such as retail, automobile may borrow more as their liquidity has been stuck due to unsold inventory.

In the last round of the central bank’s Bank Lending Survey for 2QFY20, respondents said they expected credit off-take to grow in the quarter ending March 2020. That has indeed happened; net credit to private sector business in 3QFY20 has increased by about 57 percent year-on-year. But since the onset of pandemic, those expectations should see a change in direction.

While one awaits the next wave of BLS, a special round of pandemic-based banking lending survey and other surveys conducted by the central bank would be useful to get a pulse reading of the economy. It already has the infrastructure in place courtesy its collaboration with the IBA. All it has to do is to move swiftly into action for a rapid response survey to get a sense of consumer and business confidence, bank lending survey as well as covid-related queries such as loan repayment capacity; liquidity needs for rent, labour, inventory;  loss in income and so forth.