18 July 2004	Sunday	29 Jamadi-ul-Awwal 1425

KARACHI, July 17: That the banking system has failed in giving more to its depositors even when it earns more is evident from the fact that when the banks raise their lending rates they do not necessarily increase the deposit rates as well. Sometimes when they do this the increase in deposit rates is much lesser than the increase in the lending rates.

What makes this phenomenon more disturbing is the fact that the banking sector in Pakistan has undergone a long spell of reforms that have rendered tens of thousands jobless in the name of downsizing.

Data released by the State Bank shows that the gap between average lending and deposit rates of all the banks combined widened to 421 basis points in May 2004 as the banks increased their average lending rate but kept the average deposit rate unchanged.

Weighted average lending rate of all banks put together shot up to 5.42 per cent in May form 5.07 per cent in April, but their weighted average deposit rate remained unchanged at 1.21 per cent. So, the gap between the two rates rose to 421bps in May from 386bps in April.

This 35bps increase in the spread between average lending and deposit rate points to the fact that despite all financial reforms undertaken so far, the banking system has not been able to pay more to its depositors when it earns more.

Between July-May 2003-04, the gap between the average lending and deposit rates of all the banks ranged between 340bps and 426bps. The gap narrowed to 340bps in July 2003 from 568bps in June as the weighted average lending rate came down to 5.12 per from 7.58pc and weighted average deposit rate slipped to 1.70 per cent from 1.90 per cent.

Since July 2003, the difference between average lending and deposit rate kept moving up instead of coming down even when the banks hiked their lending rates. (See table). This lending-deposit rate gap does indicate the efficiency of a banking system. The lower the gap the better the system is.

The increase in average lending rate from 5.07 per cent in April to 5.42 per cent in May 2004 is the end-result of the State Bank policy of allowing a gradual hike in treasury bills rates to contain unprecedented growth of money supply and check soaring inflation. The weighted average yield on treasury bills started moving up since mid-February this year and between March and May 2004, the average yield on six-month T-bills had gone up by 24bps to 2.07 per cent.

That indirectly pushed up the maximum mark-up on export financing from three to 3.5 per cent in June. The same rate is applicable in July. But chances are that the SBP will have to allow further hike in T-bills rate during this month or in next months. In that case, export refinance rate that is linked with six-month T-bills rate will move up and make export financing more expensive.

The biggest challenge ahead for the policy-makers is to keep inflation in check without letting the interest rates rise sharply because that can dash hopes of 6.6 per cent growth in economy during this fiscal year.

Inflation measured by the Consumer Price Index rose to 8.45 per cent in June 2004 over June 2003 and in the entire fiscal year 2003-04, it showed an increase of 4.57 per cent as the economy expanded by an estimated 6.4 per cent.

The policy-makers have planned to achieve a 6.6 per cent growth in economy in the fiscal year 2004-05, keeping inflation at five per cent. But meeting the two targets seems too difficult because containing inflation requires substantial rise in interest rates and a substantial rise in interest rates may eclipse the growth prospects.

Businessmen have already started feeling uneasy over a gradual hike in interest rates and if interest rates move further up they will feel more uncomfortable, making it difficult for the government to use the private sector as engine of economic growth. But at the same time, the policy-makers cannot ignore a steady rise in inflation numbers.

Falling interest rates since the loosening of the SBP monetary policy in November 2002 have been instrumental in bringing about several good changes in the economy, including an estimated 6.4 per cent growth in GDP against the target of 5.3 per cent. But they have also created some problems.

A key problem is that the situation created in the wake of low interest rates and rising Wholesale Price Index inflation has tempted businesses to build up inventories to benefit from price revaluation of their stocks. This issue was precisely at the heart of the wheat crisis during the last fiscal year, which finally took its toll on inflation.

This can again give birth to other such crises and the best way to avoid them is to reduce the gap between average lending rate and WPI inflation.

In June 2004, the WPI shot up 12.77 per cent over June 2003 and in the entire fiscal year 2003-04, it showed an increase of 7.91 per cent. The SBP data shows that weighted average lending rate of all the banks combined stood at 6.69 per cent in June 2003.

Now consider this: If a businessman borrowed say Rs100 million at 6.69 per cent in June last year and used this amount for inventory building, he earned a profit of double this rate one year after i.e. in June 2004 when the WPI inflation hit 12.77 per cent.

Why on earth then he would engage himself in productive activities? And if not, how the economy would grow? That is a key question the economic managers should try to address.