October 23, 2006	Monday	Ramazan 29, 1427

WHAT is the significance of a decline in commercial bank credit to the private sector after four years of continuous growth particularly when it is the private sector which has been primarily responsible for the ongoing economic upswing?

Local bankers see this depressed demand as an outcome largely of a tight monetary policy designed to tame inflation. But one foreign bank’s research report assesses the situation differently. It sees a reversal of positive macroeconomic trends indicating a “cooling off in real economic activity.”

The demand for credit for capacity modernisation and expansion in textile and cement sectors has virtually dried up. The speculative investment boom in real estate is over. The growth in the manufacturing items is narrowly based. This trend is persisting since the last two years.

Of the 13 manufacturing items whose comparable figures are available for July 2006 and July 2005, the growth is recorded for only four categories-textile and apparel, electrical goods, food beverages and tobacco group and petroleum products.

But there is consensus that the current growth rate would be more or less sustainable over the next two years. The IMF sees targeted growth of seven per cent on the back of agricultural recovery, increased development spending and higher private investment.

But the economy does not appear to have come out of the boom and bust cycle.

There is an agreement among bankers that credit volumes will pick up on seasonal demand when the cotton crop starts coming into the market. The first official estimate puts the size of the cotton crop at last year’s level of $12.4 million bales.

The bankers also are eyeing the potential for credit and investment on creation of new capacities particularly in the upcoming power projects. While the critical shortages provide opportunities for business and investment, growing macroeconomic imbalances are an increasing risk to the economy.

Critical shortages of goods and services has spurred speculative activity in stocks, real estate, commodities. They have brought windfalls to the speculators.

Crises and opportunities exist side by side. One has to look at the decades of economic crises since 1970s described by Giovani Arrighi as “systematic chaos”. As National Bank president Syed Ali Reza says there has been unprecedented wealth creation during this period. And that is more important, he adds.

It cannot be denied that National Bank is making fabulous profits but in a growing economy.

Going by the conventional wisdom, massive wealth creation whose fruits are not widely dispersed, tends to make the cycle of boom and bust more frequent and sustainable development far more difficult. The economy seems to be moving in that direction, particularly because of a high rate of inflation eroding the purchasing power of the consumers and complete absence of any income distribution policy. Last month, the food inflation rate increased to 11.3 per cent.

A recent UBS research report on “Asian Economic Perspective” says the positive trends “to some extent (continuing) will reverse in fiscal 2006-07 due to a cyclic down turn or cooling off in real economic activity”.

The positive trends that fuelled economic growth over the past four years identified by the UBS report are: the rise in private savings and investment balance from deeply negative to positive- a big surge into positive territory; expansion of commercial and entrepreneurial sector with greater access to credit and lower average rate of inflation.

Will then the decline in credit to the private sector turn out to be one of the reversals? The State Bank data shows that credit by the commercial banks to the private sector during July 1 to October 11, 2006 has fallen by Rs5 billion over the same period last year. But increased credit by specialised banks brought the overall credit to private sector on the positive side with Rs1.5 billion.

HBL president Mr Zakir Mahmood says that the decline in private sector credit growth was largely due to tight monetary policy but the credit volumes will pick during the coming cotton season. The textile sector which borrowed for BMR is now consolidating itself. Credit demand for cement sector investment may not be there but the expanded capacity would come into production in 2007 and 2008.

With the power sector expanding, there would be business for banks. Mr Zakir Mahmood sees the economic growth more or less at the targeted levels for the next two years. In his view, the most critical issue is heavy imports and he thinks that exports need to be boosted vigorously.

But officials believe that the import bill will come down this year because of falling prices of crude oil on lower international demand and the expected downturn/recession in the US economy, also resulting in slow down in the western economies. The drop in imports of machinery for cement and textiles may have its own impact but imports of power plants by Wapda based on furnace oil would inflate the import bill. Meanwhile, the imports continue to rise.

What is no less worrisome is that the export growth has slumped from 13.1 per cent last fiscal to 2.8 per cent in July-September this year. Officials suspect the fall is due to under-invoicing and the foreign exchange earnings, thus siphoned off, are coming back through workers remittance. Perhaps, rising remittances and decline in export earnings have coincided to lend support to the official suspicion. To some extent it may be true but the key issues in export is low productivity, low quality, low value addition and crony capitalism.

The savings rate, as indicated by the tax-GDP ratio, is much lower than the level of investment required to fund an economic growth of 7-8 per cent economic growth over the long- term. The shortfall in savings required for investment is being raised by foreign capital inflows.

The shift in National Savings Schemes and power policies is confusing for investors, as it diverts funds from the private to the public sector. Reformers see the government decision to allow institutions to invest in NSS as a “retrogressive step. In face of rising fiscal deficit, the government is believed to have taken the decision to finance large -scale redemptions of NSS certificates due this year. The IMF estimates that the fiscal deficit would touch five per cent of the of GDP by end of this fiscal.

In the recent past, Wapda was barred from setting up power plants. It has now been asked to improve electricity generation and supply on an emergency basis. The government is taking ad hoc decisions and is no longer worried about continuity in policies.

Gradually, the government’s role in the economy is being enlarged, beginning with a sharp rise in development spending( Rs415 PSDP) helped also by multilateral assistance, much of which is justified by enhanced programme for improving social and physical infrastructure. Are the policy makers trying to bring about a balance between the government and the market or is it a temporary pragmatic deviation?

After having integrated the domestic financial system with the international market in the first phase of the reforms, the policy makers are seeking foreign investment/loans to make up for low domestic savings.

The international markets are awash with money for want of productive channels in saturated western economies. The money coming in the form of rising credits/loans, foreign investment and workers remittances are keeping an overall external balance in surplus. Despite massive imports, the foreign exchange reserves have been sustained at over $12 billion. But the question arises: For how long if the country does not produce surpluses for export and opts for an effective policy of import substitution?