It is now clear that, following the global trend, in 2008-09 Pakistan’s GDP growth could drop significantly, necessitating the containment of its consequences on employment and social stability, and the financial services sector carries a major share of responsibility in that effort.

The president’s directive requiring power generation companies to operate at full capacity now that oil prices have fallen has had the desired immediate effect. But with these outfits languishing under the weight of huge unrealised claims on Wapda, the semblance of supply continuity may not last unless they are paid the bulk of their claims to reduce their over-stretched bank borrowing.

A substantial drop in imports (reported by banks) bodes well for the exchange reserves, but will accelerate economic slowdown spurring a rise in unemployment as industries cut their activity level. But sectors engaged in repair-maintenance work will see a rise in activity as businesses resolve to delay asset replacement and continue with their existing asset bases.

There are mixed indications from the agriculture sector. While the rice crop will exceed its target, sugar cane won’t. Thus, a part of the increased inflows from rice export will finance sugar import. About the cotton crop, besides the earlier indication of its being below the 14 million bale target courtesy mealy bug infection, the fresh bad news is slow pace of ginning due to power shortages at ginning factories.

The big worry, however, is the drop in exports. Besides the impact of power outages and high imported input costs due a weaker rupee, demand abroad is falling as the recession sets in. It is adding to the industry’s woes that faces another mounting problem – overdue export bills – that are straining the allied industries as well. Scores of factories in textile sub-sectors have closed laying-off thousands of workers.

The crisis owes itself to exports increasingly being on ‘collection’ basis or ‘on open account’ providing no payment security to exporters or their financing banks. This shift signified banks’ and exporters’ continued confidence in importers abroad although by late 2007, the US, and with it the global economy was heading for a slow down making defaults imminent.

In good times, many exporters had set up their offices abroad for selling on credit to local retail chains, and to economise on bank charges, were exporting on the less expensive but high-risk ‘collection’ basis. Now these outfits (the ‘foreign’ buyers) can’t collect the unsecured credit they extended. Yet, greed prevented exporters from reverting to the expensive but secure LC mechanism although it had become imperative.

While exporters carry the blame for the crisis – slow-moving loans – banks’ share in the mess is larger; they were supposed to know about the developing global economic scenario, and apply the brakes even if the exporters didn’t. By continuing to finance exports on collection basis after the global crisis unfolded, banks knowingly put their depositors’ money at risk.

Some banks went a step further; they swapped the rupee denominated export loans for dollar loans to help exporters cut their mark-up cost (dollar’s rate being lower than that of the rupee). It made economic sense, but banks overlooked the exchange risk it involved that could be hedged by buying currency ‘option contacts’ to limit the risk exchange even if borrowers defaulted on their dollar loans.

Option contracts assure buying a currency (at a pre-agreed rate) in which an expected inflow doesn’t materialise. If the inflow materialises the contract buyer doesn’t have to buy the contracted currency. In the present case when exporters defaulted on their dollar loans or repaid them in rupees forcing banks to buy dollars from the spot market, banks suffered losses due to the huge fall the rupee’s exchange value.

But banks alone can’t be blamed; a rupee-dollar currency option market doesn’t exist. That being the case, why, in the first place, did banks enter into such swaps and, more importantly, why were they allowed (by SBP) to do so? The explanation is over-exuberance of banks (at depositors’ expense), and market deregulation without comprehending its consequences.

Now banks are aggressively suing the loan defaulters. Surely, few deserve this treatment – exporters who accumulated the export proceeds abroad, and others who sold them to the open market – but majority of the exporters and their suppliers are experiencing a genuine cash flow crunch since proceeds of exports on collection basis are not being realised.

Non-payment by borrowers is aggravating the liquidity problem and pushing up provisioning for loan losses. To ease the liquidity crunch, SBP did a lot; now it has upped its share in export re-finance from 70 to 100 per cent releasing another Rs25 billion of banks funds for re-deployment in high yield loans. It should further boost banks’ liquidity as well as profitability

To begin with, banks should curb their over-exuberance by cutting their loan spreads. The route to un-doing their past errors, is to revive sick loans, not go headlong for business closures. By filing hundreds of recovery suits, banks are escalating the systemic risk showing a lack of understanding of interdependencies among businesses; it reflects poorly on their professionalism and vision at the frontline as well as supervisory levels.

The factor encouraging this approach is high employee turnover in banks with scant concern for the fact that the mainstay of banking is frontline bankers’ sustained inter-action with customers. A senior banker says that, in many cases, the frequently changed frontline officers don’t even know the owners of defaulting businesses, much less about the causes of their defaults, and the requisite revival strategies.

Sadly, to the dismay of banks and their borrowers, an interest rate hike now appears certain. Indication thereof was the one per cent hike in T-bill yield at the November 5 auction. Any assurances that the SBP discount rate (to which banks peg their loan rates) won’t rise, would be false because, at this auction, the yield on T-bills overshot SBP’s discount rate – an absolutely amazing distortion!

This distortion is unsustainable because it implies that SBP will pay banks a profit higher than that it will recover on lending against T-bills. Shockingly, however, according to a highly reliable source, the IMF team that visited Pakistan in September to negotiate lending terms also did not find such a distortion worrisome. The world is indeed becoming a strange place to live.

Reviving businesses in an environment of rising interest rates is a tough, creative challenge requiring both professionalism and market vision that comes with experience – in short supply in banks’ frontlines. Banks must fill this gap because that’s the resource for reviving businesses, keeping the industry’s wheel moving, and containing unemployment and the resultant social chaos.