November 17, 2003	Monday	Ramazan 21, 1424

A radical change in the strategy for economic growth is underway in Pakistan. The essence of the new approach is that the economy should be driven by consumption rather than by investment.

In the Housing Finance Supplement of Dawn, October 31, 03, there is an article entitled, “Housing finance: progress, prospects and problems” written by the Governor, State Bank of Pakistan (SBP). In that article, the Governor has observed; “There are a number of skeptics in the country who have expressed doubts about the emphasis being given to consumer financing in the country. Their mind-sets are still frozen in the traditional way of public sector and government-led growth.”

“In Pakistan private consumption is the largest single component of GDP, accounting for 80 percent of the total GDP. Thus it is obvious that any move to boost private consumption will have a much larger impact on the GDP growth than any other measure. Mortgage financing and auto-financing as key elements of private consumption not only provide strong forward and backward linkages to industrial and services sectors with a multiplier effect of 3 to 4, but also enhance overall level of private savings.” He has explained how this happens through forced saving accruing from regular instalment payment on account of the loan.

Let us first take up the philosophy of private consumption serving as the engine of growth, particularly in the context of present stage of economic development in Pakistan. This amounts to transplanting the current economic policy of developed countries and ignores the basic difference in developed and developing countries and the peculiar situation prevailing in Pakistan at the moment. The crucial difference between the two economies is the productive capacity. In developed countries the basic infrastructure of all kinds, whether economic, social, political, administrative or legal is not only fully developed, but also constantly improved.

In short, there are no economic irritants worth the name and, as a result, there is very little supply constraint. Moreover, the economy is integrated without any dichotomy of distinct urban and rural sectors, or the elite wallowing in dirty wealth and the masses in grinding poverty Their lacklustre growth at times is essentially due to lack of effective demand and this is stimulated, among other policy measures like tax cuts, by encouraging consumer credit.

The situation in most developing countries at the lower-end is just the opposite. Pakistan offers a classic example. There is no dearth of resources, both human and material, in Pakistan and it is endowed with ideal climatic conditions. In the sixties, it was commended as a model of development and many countries tried to follow it. However, it started sliding down so much so that it is now at the bottom of the totem pole among the comity of nations. The nineties are taken as the “lost decade,” so far as economic growth is concerned, even though private and public consumption recorded a significant increase. Consumption was never to blame for the faltering growth rate. The situation has been no different in the twenty first century. The actual experience in Pakistan discredits the thesis of consumption as the engine of growth. The relationship between the two, if any, is not positive but negative.

The very weak linkage between consumption and economic growth in Pakistan is explained by the nature of the economy, which continues to be primarily rural and agricultural; agriculture accounting for as much as one-fourth of the GDP. It is well recognized that this sector is susceptible to natural factors more than anything else. Not only economic infrastructure has been grossly inadequate but has been of late crumbling down for lack of proper maintenance and this is a positive hindrance to optimum use of productive resources in the country.

Rampant corruption has eaten into the vital organs of almost all national institutions and there is a prohibitive cost of doing business, in money, time and inconvenience. Only the affluent well connected can survive, not to speak of thriving, in this inhospitable environment. This has created rigidity in the production structure. The law and order situation is a matter of grave concern as it affects not only security of life, property and honour of the individual, but also economic life for difficulty in entering into contracts and their subsequent enforcement. This impacts new investment, both domestic and foreign. International financial institutions have taken cognizance of this important factor and are urging government to do something about it. They are ready to provide funds for that purpose.

No body holds brief for government-led and managed growth model any more. However, government cannot be excluded from the process of economic growth, which, in turn, cannot be conceived without investment. The latest Annual Report of the State Bank for 2002-3 (Volume 1) observes: “The biggest challenge facing the economic managers in the short run is to create as many jobs as possible. The policy focus therefore should shift to (1) increased government spending on human resource development and infrastructure and (2) greater investment by the private sector. So the crux of the problem is the public-private mix and the relative role of government and its nature. It is agreed on all hands that government role in economic life should be that of a facilitator and not of a manager.

For Pakistan, this means privatization of all government business enterprises and government to concentrate on creating an enabling environment for the private investor. This in itself is a daunting agenda including law and order, fair and speedy resolution of disputes of all kinds, economic infrastructure, education and health. The traditional paternalistic attitude of government offering to do every thing from defence to dance, sports, arts and culture will have to be given up. This has spread the state resources so wide and thin that practically nothing is done properly and effectively. To be effective government must trim its sails and confine itself to the core functions.

Turning to the specific measures, under the new strategy, to promote private consumption, as the engine of growth, it may be pointed out that there can be no quarrel about the need for housing finance even otherwise. There can be no denying the crying need for housing finance in the country, as shelter is a basic need, which at present is not met for the millions. This was recognized long back when the House Building Finance Corporation (HBFC) was set up in the early fifties. The question is about bringing commercial banks into mortgage financing of housing in a big way, which is rather novel in financial history.

Mortgage financing of housing is not a new and untried concept in the country. This is exactly what HBFC has been doing ever since and will have a much larger role in the new scheme of things. Its experience can be of great help. Commercial banks were not in the business of mortgage finance in the strict legal sense but they have been lending against the security of real estate. Their loans in this category had increased from Rs. 99.1 billion in June 2001 to Rs111.01 billion on the same date of 2003. Of the total loans in this category, those against residential buildings had risen from Rs48.9 billion to Rs58.3 billion.

The package has been conceived in the context of excessive liquidity of commercial banks and the sharp decline in interest rates, which makes banks look for alternate lending opportunities and develop asset-based consumer products. Housing finance provides an attractive opportunity, as both profit margin and recovery rates are believed to be on the average higher for mortgage finance than project and corporate lending. In order to provide an institutional arrangement and direction to reform housing finance, a ‘standing advisory group’ has been set up in the SBP to implement the recommendations of the Housing Finance Conference held in December 2002. The group has sequenced the reform agenda. As the first step, efforts include the State Bank persuading government to provide tax incentive for investment in housing in the federal budget 2003-4, broadening of the scope of Credit Information Bureau in the SBP, establishing ‘credit information bureau’ in the private sector for consumer loans, rationalizing stamp duties, registration fee and property taxes and ascertaining enforcement of recovery procedures in case of default by mortgagers.

As fiscal incentives, tax credit on borrowing cost of housing loans has been enhanced to Rs0.5 million, or 40 per cent of the income of the mortgagers which ever is less, the limit of property income for withholding tax has been doubled from Rs0.1 million to Rs0.2 million and the rate reduced from 7.5 to 5 per cent, profit or interest on mortgage of property or other capital charges have been allowed to be deducted for the purpose of income tax, CED on wires and cables has been withdrawn, excise duty on cement reduced by 25 per cent, import of construction machinery has been allowed at concessionary rate of 10 per cent import duty, banks have been allowed up to 3 per cent of the income arising from consumer loans for creating a reserve fund to offset bad debts in this segment.

In order to liberalize bank credit for this purpose, the maximum per party limit has been increased from Rs5 million to Rs7.5 million with debt equity of 80:20 instead of 70:30. The period has been extended from 15 years to 20 years. The banks’ exposure to housing finance has been doubled from 5 per cent to 10 per cent of their net advances.

The HBFC has been reactivated, after a hiatus of almost two years, and its credit conditions liberalized, more or less along the commercial banks line. The loan limit, which was Rs. 2 million at the time of resumption of activity and subsequently raised to Rs5 million, has been further enhanced to be at par with commercial banks while the repayment period has been extended from 20 years to 25 years. Debt equity ratio is 70:30.

It is obvious that the way the above package has been developed, it will be more beneficial to the elite in the higher income tax bracket than the small man. No wonder the response to the commercial bank facilities has been quite positive and during April-June 03, gross disbursements by the banks under the scheme were of the order of Rs600 million. During 2002-3, the banks’ outstanding financing for housing loans stood at Rs3.8 billion. The HBFC’s annual disbursements are around Rs1 billion.

As expected, the elite has been quick to avail of the facility without really needing it. According to the SBP Governor, “Banks have been selective in their approval and at present focusing on ‘outright purchase and renovation’ loans mainly to the upper income groups for unlocking their equity investment in housing properties.

This trend. may continue for some time, but as banks develop expertise in origination, underwriting, approving and monitoring housing loans then construction finance for middle-income groups would be the major focus of the banks.” It is no wild imagination, but a statement of experience that by the time banks are ready to cater to the middle-income groups, the elite would pre-empt the resources and banks would be up against the prescribed exposure limit. This would be a ready excuse to refuse credit to that group.

The experience of lending to the elite by financial institutions in general and commercial banks in particular ending up in ever increasing non-performing loans (NPLs), despite all rhetoric but half hearted measure to reduce them, is quite a painful, if not shameful, story, to say the least. What is the guarantee that the new scheme of housing finance, which is also available for the nebulous purposes of repairs and renovation- a glaring loophole for misuse of credit, would have a totally different fate?

The HBFC had a good beginning as a small man’s institution when the upper limit for loans was low and did make a valuable contribution in providing shelter for the small man. However, as the limit was enhanced to embrace the elite, builder mafia high jacked it and it fell on bad days and soon became notorious for corruption.

Shelter is a basic human need and can be served by a small and medium-sized house of functional nature. Palatial house with lot of embellishments of Victorian pillars and fancy fittings mostly imported do not add to the basic utility of a house but is only a means of satisfying ego, wasting precious national resources. Institutional credit should not be allowed for this kind of conspicuous consumption at the expense of the small man who is denied the facility to meet the minimum requirement.

If the scheme is not just to provide an avenue for the use of excessive liquidity of commercial banks but serve a vital social purpose, it needs to be modified to reverse the existing tilt in order to favour the small man. Firstly, in order to preclude the possibility of misuse of funds the facility of loans for repair and renovation should be done away with. Secondly, the terms of loans should be modified to facilitate small and medium sized loans for which different slabs may be created. The lowest slab should be up to Rs 2 million repayable in 25 years with debt equity ratio of 80:20. The next slab should be Rs2-3 million with a debt equity ratio of 70:30 and repayable in 25 years. The third slab should be Rs. 3-5 million with a debt equity ratio of 60:40 and repayable in 20 years. The top slab should be over Rs5 million with a debt equity ratio of 50:50 and repayable in 15 years. Interest rate or return on loans should also be graduated to be the lowest in the lowest slab, which would be justified by the known low risk of default in this category, apart from the capacity to repay. Thereafter, the rate should be graduated in each slab to take into account the risk premium.

To covert money into brick and mortar, developed land, with all necessary amenities like approach road, electricity, water, sewage etc, is required. Unless this is ensured in a coordinated manner, extension of credit would only push up the price of existing houses without any addition to the stock. This cannot be left to the private sector and would entail large public investment. There are lots of scandals already on this account and many investors are ruing the day not for years but decades.

Commercial banks have also introduced many other schemes of consumer credit in the country. According to the State Bank Annual Report, the volume of consumer credit has witnessed spectacular growth from mere Rs6.1 billion in end-June 2000 to Rs45.1 billion in June 2003, or by more than seven-fold. Personal loans (others) account for 41 per cent of the total credit followed by auto-financing with 35 per cent share, housing finance with 15 per cent, consumer durables with 1 per cent and credit cards with 8 per cent share. In absolute amount, auto-financing increased from only Rs3.5 billion in FY 2001 to Rs15.8 billion in FY 2003 while housing finance reached Rs3.8 billion. Outstanding financing through credit cards stood at Rs6.7 billion at end FY 2003. The growth of consumer durable finance is not indicated but can be derived at Rs 450 million in 2003. Personal loans (Others) have witnessed a tremendous growth over the past two years and had reached Rs18.4 billion in 2003. The banks were already allowed clean (unsecured) lending up to Rs0.1 million and Rs0.5 million in case of credit cards to individuals but they aggressively marketed their tailored products for personal loans during FY 2002 and 03.

Housing finance can have some economic and social justification for their linkage, though weak, but auto-finance is for consumption pure and simple. It may have eased the conveyance problem for some but has only added to the already unbearable congestion in principal cities and created the problem of long wait, even after payment of large initial deposit, often of full price, and price premium. Auto industry is capital intensive and with multinationals who would make good remittable profits putting pressure on the balance of payments. It would be much better, if instead of auto financing for individuals, banks promote the formation of broad based properly managed transport companies to eliminate the individually owned yellow death vehicles running on roads called mini buses.

Promoting consumption in a country with very low rate of saving and investment is not an appropriate policy. It would only aggravate the situation as consumption cuts into saving and constraints investment. Pakistan has one of the lowest rates of domestic saving in the world at only 16.2 per cent of GDP in 2002-3. Supplemented with foreign savings gross total investment could not exceed 14.8 per cent of GNP , whereas a minimum of 25 per cent is expected for a reasonable sustainable growth rate.

Excessive liquidity with commercial banks is offered as the justification but this is only a fallacy. Banks have excessive liquidity because they do not perform their proper functions of meeting all the genuine credit requirement of the country as a whole. There is so much of unsatisfied demand for institutional credit in the country in general and in the rural areas in particular,that even if the current excessive liquidity were to be doubled, it would not suffice.

The problem is with the banking culture in which commercial bank officials prefer elite clients in big cities, even if they prove themselves not so credit worthy with a record of NPL, to uncouth, illiterate, but highly credit worthy for their repayment history, commoners, particularly in rural areas. Many rural areas have been recently denuded of banking facilities on the plea that they were making loss. They were making loss not for any inefficiency but because there was no lending by them in their respective areas. Many a time bank officials cultivate elite clients in the hope of their possible help in career advancement or some other reciprocal benefit.

What is not recognized, if so at least not mentioned, is the hard fact that the SBP is also unwittingly responsible for excessive liquidity with commercial banks. In its assumed developmental role, the SBP has been injecting purchasing power into the economy by capitalizing the financial institutions or refinancing them for certain priority programmes even when banks sit on plenty of their own resources. Refinance for export finance is a prime example.

As of end-June 2003, the SBP accounted for creation of as much as 15 per cent of money supply in this manner. This used to be much higher sometime twice as much, prior to the recent shifting of government securities to the banks. The central bank serving as a source of prime capital is a phenomenon unique to Pakistan. The earlier it sheds this relic of the fifties assuming absence of private capital in the country better it would be for its discharge of its essential functions as a prime regulatory agency, which were in the past put on the back burner because of enthusiastic pre-occupation with the developmental role.

The irony is that in Pakistan economic managers espouse the cause of market mechanism, are never tired of eulogizing its merit and some time take measures to allow it work, largely at the behest of international financial institutions, but shy away when it comes to allocation of resources by the market mechanism. Perhaps in the heart of their hearts they do not want their much-cherished traditional personal power to allocate resources to be surrendered to an impersonal institution making allocations through the blind price mechanism. The result is that economy ends with a mixed-up system with distortions making it very difficult to manage.