September 22, 2002	Sunday	Rajab 14, 1423

KARACHI, Sept 21: How long will the financial sector reforms last?

The State Bank is working on a ten-year vision, that sets the strategic direction. The short-term strategy is to complete the set of reforms initiated in 1991.

Finance Minister Shaukat Aziz says that “the Chinese authorities keep telling us, they started financial reforms in China 15 or 20 years ago. My Chinese counterpart tells me at least we have the same number of years to go.”

Without specifying the time it would take to complete the reforms he observed “it takes times. It is not easy.”

There are many differences in the approach and outcome of the reforms undertaken by Pakistan and China. China has chosen the sequence and the timing of the reforms to ensure one of the highest economic growth, if not the highest, in the world. In Pakistan, the economic growth rate has suffered due to stabilization programme. Officials here say that sustainable development and growth can be only ensured through fiscal discipline.

The two economies differ in many ways and may not be comparable. For example, unlike China, Pakistan lacks political stability. In China, says a local banker, the banking reforms are being delayed to manage a high economic growth.

China is switching over from socialism to market economy. Pakistan had a mixed economy that was more open to outside world than its neighbours, China and India. The commanding heights of the economy under state control are being privatized.

Given the different background of the two economies, the duration of the reforms should vary.

Yet the banking sector reforms since 1997 indicate, it would take many years more for these institutions to catch up with the modern global trends.

The local banks are heavily dependent on incomes from interest whose rates are declining on a global scale. In industrialized states, it is asset managers and not banks that tend to dominate the financial market. Their growth is performance-based. They do not belong to the rentier class.

In Pakistan, 75 per cent of the earnings of all banks come from interest and the rest flows from fees and commissions. In India, the ratio is stated to be around 60-40. The banks here are slow to design products and broaden service base to diversify their sources of incomes. It is one of the reasons for high lending rates. The Japanese interest rate is zero, the US rate is 1.75 per cent and borrowers in Pakistan are denied a single digit rate.

With economic reforms, at home and abroad, placing priority on a low inflation rate, interests have to come down gradually. Industrial economies may be even hit by deflation. It is declining interest rates that is now making exports competitive rather than depreciation of the rupee. The current global economic slump would not go away soon. On a long term basis, it would mean low rate of interest.

Sooner or later, the local banks are likely to face a challenge from the capital market if they do not perform well. The intermediation costs of major banks, not performance-based, put the major nationalized or public sector banks in the category of rentier class. Their reforms have been heavily financed either by borrowed World Bank funds or by the State Bank/national exchequer.

If the banks are not doing well, or they do not have the service base or their product pricing policy is out of line, you have the alternative, which is the capital market for equities, for debt or other products, says the State Bank governor, Dr. Ishrat Husain and adds “this is the message in the area of financial sector reforms.”

Dr. Ishrat says the corporate sector should be able to mobilize a significant portion of its long term financing needs, equity as well as debt, from the capital market.

“You have long term pool of funds from pension funds, provident funds—contractual savings—and from mutual funds” whose managers are “looking for long term investments. On the other side, there are projects that require long term financing. Thus, you have a demand side and a supply side, both looking for a match up of long term finance.”

He is confident that the innovations that are coming into the TFC would help develop long term finance. The banks say that they have no role to play in project financing. In recent years, the number of banks, their branches and their area of operations, have been shrinking. Only the presentation of their financial performance has improved.

Despite a decade-long reforms with some laudable outcomes, the financial sector is beset with many problems and difficulties.

Some of the problems identified by the State Bank are: foreign exchange market and existing financial sector are fragmented. Asset portfolio of large commercial banks are seriously infected. Small private banks have weak capital base with limited competitive ability. Private investment banks are facing extinction.

Under the medium-term strategy, the State Bank is addressing these issues. The central bank wants strong but fewer banks. The wave of mergers are creating stronger financial institutions, offering a variety of financial services under one roof. DFI concept is dead. Investment banks would soon become extinct but investment funding would become part of universal banking or financial super markets. The credit rating is intended to keep the clients- depositors aware of the financial health of all banks.

Under the long-term tentative thinking of the State Bank, the reforms aim at creating self-sustained commercially viable institutions with no government support either in respect of resource mobilization or pricing of product. And the financial sector would be predominantly owned by the private sector.