Privatisation seems to be all the rage in Pakistan these days with the prime minister pointing to the ‘turnaround’ of the banking sector after privatisation. He is not alone.
Many people are given to understand that privatisation turned lethargic, corrupt and inefficient nationalised commercial banks (NCBs) into efficient, profitable and dynamic institutions which have since been contributing heavily to economic growth in Pakistan. The reality, however, could not be more different. Since privatisation, the banking sector has delivered enormous dividends for the new owners, albeit mainly at the expense of the economy. We elaborate below:
The 1990s and 2000s saw a reversal of Bhutto’s nationalisation of the big commercial banks in Pakistan on several pretexts.
First, it was alleged that nationalised banks were inept, bureaucratic and inefficient. Second, it was pointed out that nationalised banks were not extending sufficient credit to manufacturing, agriculture or small and medium sized enterprises (SMEs), preferring instead to loan money to the government through purchase of risk-free government securities.
Third, it was said that due to corruption and suboptimal risk assessment non-performing loans (NPL) had become too high — 19pc in 1993. Finally, interest rates were being kept low to suit the heavy government borrowing, something that also served to discourage savings.
Using the above justifications an impressive privatisation campaign was launched. The process was always heavily skewed in favour of the buyers who, at least in some instances, paid bargain basement prices for these highly profitable entities after the government had injected some Rs45 billion in equity into the banks, transferred another Rs50bn or so of bad loans to a separate entity and facilitated massive layoffs and closure of nearly 1,600 branches.
Since privatisation, however, the contribution of the NCBs to the economy seems to have worsened sharply instead of improving with lending to the private sector currently at its lowest level since 1963. Loans to private businesses as a percentage of GDP stand at around 16pc (it is 50pc in India and 112pc in Malaysia). NPLs are higher than the pre-privatisation levels (the official figure is 17pc though if one considers only commercial lending, their proportion is estimated to be anywhere between 25pc to 30pc).
The sectoral allocation of credit has not improved very much either with manufacturing and agriculture, the sectors which were supposed to benefit from privatisation, both suffering. SMEs are more neglected than before. DFIs traditionally provided long-term financing for key sectors. Given that they were discarded in the reforms and with banks shying away from this crucial activity, the development process has been dealt a major blow in the country.
The banks’ lack of appetite for lending has not affected profits though. Instead, banks have been hugely profitable thanks to a) a big difference between lending rates and deposit rates (this difference is called ‘spread’); and b) large holdings of high-yielding government securities.
Between 2004 and 2010, spreads in Pakistan averaged over 6pc (compared to 2pc in Korea and 3pc in Malaysia for the same period, with lending rates doubling from 7pc to 14pc between 2004 and 2011, while deposit rates on savings remained low — negative in real terms.
The latter has prevented any meaningful saving mobilisation (deposits/GDP ratio for Pakistan is close to 30pc as against an average of 65pc for emerging markets).
Much of the banks’ income seems to be coming from investment in government securities (offering returns of almost 12pc for many years). Recently investment in high-yielding government securities has touched 50pc of total assets in the case of the most profitable bank, MCB. Whereas in the pre-reform era the banks were lending to the government at low (capped interest) rates, the same banks under private ownership are still lending heavily to the government, but at much higher interest rates, which makes them extremely profitable, but contributes to further increasing the government’s debt burden. To make matters worse, under Shaukat Aziz, the tax rate levied on banks was also brought down from 56pc to 35pc.
The banking sector is there to fulfil a developmental role in the economy. How well this role is played hinges on lending at favourable rates to key sectors.
In the case of Pakistan, private banks simply do not have the appetite to lend to industry or agriculture, let alone to SMEs.
If the government is going to continue borrowing recklessly, it is actually counterproductive to have privately owned banks. The sooner the government understands this, the better it will be for all of us.
Kamal Munir teaches Strategy & Policy at the University of Cambridge. Natalya Naqvi is a PhD student at the Centre for Development Studies, University of Cambridge.