Never mind ADR loans, private credit is back with a bang

24 Dec, 2024

That’s right. Over the past three months – Aug to Nov ‘24 – credit to private sector businesses has increased by nearly five percent, excluding the banking ADR loans bonanza. This is the most robust growth in credit recorded by commercial banking advances to businesses (non-financial firms) since June 2022 when Pakistan’s economy officially entered the balance of payment crisis at the height of the post-pandemic commodity super cycle.

Don’t believe it? Look no further than SBP’s credit classification by facility type to private sector businesses. Between August and November, the total stock of borrowing by businesses rose by nearly Rs 1.6 trillion, which was a record 22 percent increase over a three-month period. However, since it is well established that many of these advances were made by banks to meet their Advances-to-Deposits threshold of 50 percent to escape the super tax, it is correctly argued that the loans made for window dressing purposes shall not add to productive activity in the economy. But can this be said about all loans made during this period?

Not per our assessment. BR Research estimates that at least 20 percent of loans made during this period are part of business-as-usual, as they represent drawdown of financing facilities that are par for the course. These financing facilities are either priced such that their additional drawdown does not offer the borrower a short-term arbitrage in the same way as credit lines extended below Kibor may do. Or whose tenor and settlement is not linked to calendar year end.

Too dense? Let’s break it down. First off are export-linked financing facilities such as dollar-denominated FE-25 loans, bill discounting, or even Export Refinance loans. An additional drawdown of Rs100 Bn in these loans – even if it helps commercial banks meet their ADR targets – must still add to productive activity in the economy, as the settlement or repayment of these loans is contingent upon the realization of export receipts. Similarly, the pricing on Export Refinance loans or the long-term TERF & LTFF loans is either fixed or linked to the policy rate, which means banks by regulation cannot advance these loans at below policy rate.

Similarly, long-term debt has recorded a resounding increase of Rs137 Bn – nearly half a billion dollars – in just three months, again their highest increase since June 2022, both in percentage and absolute terms. Interestingly, Rs36 Bn of these loans include fresh financing extended under LTFF or TERF (unspecified) to two peculiar industries: hotels, and iron and steel. Since SBP has officially terminated fresh lending under concessional long-term financing, it is likely that these represent fixed investment loans that were previously approved by both the lending institutions and the regulator but may have been shelved due to various reasons, such as economic uncertainty. Regardless, these loans most definitely carry fixed pricing. Similarly, Rs84 Bn has been advanced in commercially priced long-term loans to various industries, many of which have been deferring their overdue BMR due to historic markup rates previously. Regardless, since no commercial bank in its right mind would extend fixed pricing on long-term loans at below Kibor just to meet a short-run ADR target, it is highly likely that these loans represent genuine borrowing for capex.

The momentum in private sector borrowing is real and is buoyed by market participants anticipating that average borrowing cost in the coming calendar year will drop materially, allowing leveraged investment and expansion to once again resume. And regardless of the fate of ADR loans post December, the momentum is here to stay.

The above analysis assumes that between Aug-24 and Nov-24, all Pak Rupee-denominated lending under commercially priced Working Capital Financing Facilities such as Running Finance, Cash Finance, short-term advances, etc represent phantom loans made explicitly to meet the ADR target, that may be retired once the calendar year is over and have been directed towards investment in financial securities such as government bonds or equities to earn an arbitrage, and shall not contribute towards productive activity in the real economy.

The author estimates this figure to be a maximum of Rs 1.25 trillion. It is important to emphasize that this amount MUST be an exaggerated assumption, considering Q4 records a genuine seasonal increase in Pak rupee-denominated working capital borrowing emanating from textiles, sugar, rice, and other segments, primarily for raw material procurement due to harvest months. In fact, it is likely that up to 20 percent or Rs250 billion out of the Rs 1.25 trillion may have flowed into the real economy, which means the size of the true scale of growth in private sector borrowing is significantly higher – up to 6.5 percent since Aug-24. This is particularly significant considering that the borrowing has taken off when 3M Kibor is still very much in double-digit territory.

Read Comments