“Private sector credit declines by 39.7 percent”, read the headline in this newspaper yesterday. The headline, attributed to the monthly Economic Update for May 2024 and issued by the Economic Adviser Wing (EAW) of the Finance Division, obviously paints a very dark picture. However, the reality might not be as mind numbing.

Private sector credit has most certainly stagnated, however, painting the picture of a precipitous decline of forty percent may be stretching the details too far. According to latest monetary aggregates released by the State Bank, also referred to by the Finance Division in its monthly reporting, net flows of banking sector advances to the private sector stood at Rs77 billion during the financial year 2023-2024 to date (30-June-2023 to 03-May-2024), compared to net flows of Rs128 billion during the same period last financial year.

This is by no means shocking. During the period under review, the benchmark markup rate on private sector loans – 3 months Kibor - has increased by nearly 5 percentage points – from 17.48 percent in FY23 to 22.3 percent in FY24TD. Although it should be obvious – but still bears emphasis,net flows are not the same as gross disbursements. Meaning that despite historic high interest rates, the private sector is yet to begin net retirement of loans.

That the pace of net flow of loans has slowed down a tad bit after a 5-percentage point increase in markup rate over the corresponding period should not come as a surprise. In fact, it is just as likely that the gross disbursement of fresh loans has kept pace with inflation. However, as the news report itself points out, the slowdown in various large borrowing segments of Large-Scale Manufacturing (LSM) segment may have let to targeted retirement by key industries, lowering the final number of net flows of advances to private sector.

In fact, the fact that should truly give pause to decision makers both at the Chundrigar and Q-block is the million-dollar question: how exactly has the private sector managed to fare so well despite historic inflation and interest rates over the past two years. In fact, after 22 months of headline inflation, and 15 months of policy rate above 20 percent, the non-performing loans (NPLs) portfolio of the banking sector is still under 8 percent, which is not only well below its historic average, but is a whole percentage point below the monthly readings between September 2018 and September 2021, when both inflation and the policy rate averaged at just nine percent!

This is no small achievement. In the US, a one percent rise in benchmark interest rates is historically associated with a 15 to 20 percent rise in loan defaults, with higher default rates for subprime market segments. In contrast, between March 2023 and March 2024, total NPLs for the banking system in Pakistan increased by a mere 1 percent, during which the policy rate increased by two percentage points – from 20 percent to 22 percent. In fact, the largest increase in total NPLs came during the preceding period between March 2022 and March 2023, when total NPLs for the banking sector by Rs125 billion – or 14.5 percent – after an 8-percentage point rise in the benchmark policy rate during the 12-month period.

This is of course not a sufficient argument to keep policy rates at current historic levels, or an insistence that the real interest rate should remain stubbornly unchanged in face of declining inflation and improving 12-month forecasts. However, a deeper investigation is nevertheless warranted into discovering the resilient nature of private sector credit in the face of never-before-seen levels of markup rates. Across the globe, overly leveraged or poorly managed weakest links fall whenever the cost of borrowing rises. That NPLs have remained stable could also point to dysfunction in the monetary transmission mechanism, possibly enabled by fixed rate loans made during the pandemic.

Without a concrete investigation and review of empirical evidence, any argument for relaxing the contractionary monetary policy stance should be called for what it is – vibes. The large-scale manufacturing production index may very well be in the negative territory, but LSM industry segment is also the largest customer of banking credit within the private sector, possibly accounting for up to 50 percent of outstanding credit to private sector borrowers. Yet, not only has the NPL ratio for this segment not increased, it remains well below long term average. Even the slight uptick in the SME/commercial segment is still well below the high growth period of 2021-22.

If the monetary policy is to ever have a desired effect on price stability in the economy, the policymakers must be equipped with the right data to guide them in making decisions that impact lives of millions of Pakistanis. Lazy explanations – such as the recovery in the agri economy which itself is an insignificant borrower – should not suffice.