IN the first quarter of FY 2007, credit off-take has been below expectations while repayments (many representing pre-mature settlement) have been high. Rise in outstanding credit over FY06 has therefore been only 1.5 per cent, raising fears on an economic slow down. For the government, it should be unsettling since the impact of the slow down could soon become undeniably visible, making 2007 – the election year – a difficult period.

Economic slowdown in Pakistan is not an oddity; in varying degrees the trend is visible globally but what is worrying that its impact may be more pronounced because Pakistan faces a host of problems.

There are purely economics-related factors including the rapid rise in lending rates (from 2-12 per cent per annum in the last 12 months), rising inflation that is sapping industry’s cost efficiency, a managed exchange rate that won’t be sustainable, stiff competition from cheap imports that are undermining consumer durable producing sectors, and slow decline in both exports and domestic demand (interestingly enough even for locally-assembled cars and motorbikes). It is feared that inability to check these trends may force a reversal of the current fiscal and monetary policies.

According to bankers, however, the factor causing the drop in credit off-take is growing uncertainty about the future, which the World Bank has rightly called ‘inadequacy of cushions’ to withstand external shocks, while hinting at Pakistan’s exchange reserves that progressively form a lower percentage of its escalating trade deficit.

World Bank remark about ‘lack of cushion’ isn’t a surprise because observers had been pointing to the developing economic vulnerabilities as trade deficit soared rapidly in the aftermath of oil price hike and liberal import of goods with marginal utility.

They persisted with a stance that seemed aimed at making Pakistan resemble western economies in terms of low single digit fiscal deficits and inflation, high but consumption-oriented growth, and economic de-regulation. This flawed policy couldn’t deliver the results Pakistan needed. IMF too has expressed its anxiety over the build up of the trade deficit and growing inadequacy of foreign exchange reserves to fund that deficit.

The over-exuberance that characterized the de-regulation process, especially on the financial services and import-oriented sectors, precipitated the ensuing economic downturn. Despite warnings that GDP growth (painted as a ‘success’) was deceptive because it reflected a dangerous rise in consumption fuelled by imports, policy-makers remained unconcerned about preventing this distortion from escalating. It finally seems to be crystallizing but it is a bit too late to correct the course without causing more than just a ripple.

It also proves that hurriedly deregulating economies is fraught with risks whose crystallisation can force re-regulation and hurt the sentiment for investment – something a country with a high population growth rate simply can’t afford.

According to bankers, while introducing floating rates of interest neither they nor their borrowers visualized that while this pricing basis keeps borrowing cost in line with prevailing interest rates, it rises as rapidly as do the market rates, more so in markets where inflation indices are fiddled to artificially pull down interest rates for a while, but not for ever. That‘s what happened in Pakistan, and a bit too soon.

Because of inexperience in dealing on floating rates (and the fact that the period when they were introduced, interest rates everywhere were at their historic lows), projections of revenues, financing costs and profitability relied too heavily on sustained low interest rates. Rapid rise in interest rates turned these projections upside down. While clever borrowers (mega customers) repaid their loans or re-priced them on fixed rates, most borrowers are in a fix. Bankers now fear a significant rise in loan defaults 2006 onwards.

Exporters are in bigger trouble. With a global economic downturn setting in, they are finding it harder to sustain their hold on foreign markets that are now far more competitive. This brings into question another aspect of the capacity residing in commercial banks.

With $6 billion worth of investment over the last six years in balancing, modernisation and replacement of its industrial base, why isn’t the textile sector poised for sustained export growth?

The fact that this sector is slowing down in spite of this investment gives the impression that technology import was not focused on meeting the coming competitive challenges. Lending banks obviously lacked the capacity to forestall this unwanted outcome through multi-dimensional assessment of the risk involved in export-oriented project finance.

In the de-regulation drive, DFIs were closed on the assumption that commercial banks can undertake project finance (seemingly, without developing a credible capacity there for). Many banks still lack the capacity for risk assessment because they don’t deem it necessary to setup investigative units for assessing the sourcing, technical advantages, productive life, pace of obsolescence, and pricing of the plants as well as the research needed to assess the impact of technology change in competitor countries, on the projects being financed by them.

Banks rely on borrowers’ expertise in these areas, which is wrong. While deregulating the banking sector, in our over-exuberance we forgot that DFIs failed because of these very weaknesses although they had at least the infrastructure there for (no matter how rickety); what they needed was a revamp thereof, not closure.

We also ignored re-structuring of the economy to steadily reduce its dependence on the textile sector. We allowed this sector to remain the mainstay of the economy and made the state hostage to its demands. Any drop in textile exports now sends shock waves across the economy.

According to the latest figures, during July-September 2006 textile exports fell by eight per cent (or $129 million) over those recorded in the corresponding period last year. Exports of other items too have either stagnated or fallen over their last year levels but drop in textile exports – the largest chunk of exports– becomes a major crisis.

A sustained reduction in activity in this sector could push-up an already high unemployment, with ripple effect in other sectors including cotton production, value-addition chain of the textile sector, and its infrastructure support services.

Setting-up of the National Textile Strategy Committee (NTSC) is a positive move to identify impediments to growth of this sector. NTSC will primarily focus on increasing market access (for which the government must use its diplomatic muscle), and cost of doing business (for which the government must agree to new fiscal concessions and subsidies).

The agenda includes fundamental issues including production of standardized cotton grades, product diversification, capacity enhancement and technology up-gradation of the value-addition chain, development of a sector-compatible infrastructure and transport and communication system, capacity building of human resources, and watching trends in textile exports to identify high-end product markets.

Interestingly enough, it doesn’t include identifying loss-making basic activity sub-sectors for disinvestment and acquiring units abroad that offer major economies although it may be time to do away with the lower end of the yarn manufacturing sub-sector and investing in higher yield activities.

While there is no doubt that similar exercises must be conducted for other sectors to ensure their long-term health, implementing improvements will take time. What we need now is a short-term strategy. It would be futile to rely on subsidies (that only escalate the fiscal deficit) to exports to forestall an economic slowdown.

Gradually realigning the exchange rate would be a less expensive route; it could meet exporters’ needs and exercise a rationalizing influence on imports without imposing controls. With this strategy, GDP growth may still be sustainable above six per cent, not otherwise.