As foreign funding has yet to come into the nation’s coffers, the government keeps relying on borrowing from the central bank to plug holes in its fiscal account. This is one of the reasons for higher inflation as the government’s borrowing from the State Bank of Pakistan (SBP) effectively means additional printing of currency notes.

But so far, the government has purposely avoided borrowing from commercial banks. This has enabled banks to lend generously to the private sector.

Foreign exchange reserves held by the SBP continue to decline. On Oct 26, reserves plunged to $7.77 billion, enough to cover imports of just one and a half months, from $9.79bn at the end of the last fiscal year. The external sector will start shaping up once Saudi Arabia’s promised $3bn is placed in the SBP account. The situation will look much rosier if Prime Minister Imran Khan’s visit to China results in an immediate inflow of dollars into our national accounts.

One factor behind higher private-sector credit off-take is the fall in the profitability of some key industrial sectors that rely heavily on imported raw materials

Meanwhile, banks continue to lend liberally to the private sector.

In less than four months of this fiscal year — between July 1 and Oct 19 — banks made net lending of Rs165bn to the private sector. In the same period a year ago, they had made a net recovery of Rs21bn from the private sector instead. What has changed so dramatically?

One key factor is government borrowing. Between July 1 and Oct 19, the federal government borrowed Rs2.39 trillion from the SBP and retired Rs2.14tr worth of commercial banks’ credit. That, in turn, freed up space for banks to lend more to the private sector. This is on the supply side.

Is some unmet demand also a reason? Yes, of course. In 2017-18, banks’ lending to the private sector stood at Rs775bn against the target of Rs1tr. “Unleashing of pent-up demand was expected during this fiscal year and we are witnessing that now,” says the head of a large local bank. “Besides, businesses are also borrowing more in anticipation of a sharper increase in interest rates in response to a weaker rupee and higher inflation.”

In the past 10 months, the SBP has raised key policy rate by 250 basis points in its fight against weaker rupee and rising inflation. Private-sector businesses, after enjoying low interest rates, know that the party is over.

“The era of keeping the rupee overvalued and maintaining low interest rates is gone. Businesses are borrowing more now to mitigate the lagged impact of already tightened interest rates and keep the annualised cost of funds from rising too high in the case of further tightening,” says a senior executive of one of the top five banks.

Another factor behind higher private-sector credit off-take is the fall in the profitability of some key industrial sectors, such as automobiles, chemicals and fertilisers, electronics and paper and board manufacturing, that rely heavily on imported raw materials. They are in trouble after a massive rupee depreciation of 27 per cent in the past 10 months and the imposition of higher import and regulatory duties. In 2017-18, higher profitability of these and some other sectors had enabled the private sector to live on limited borrowing from banks.

This is not the case now. Faced with lower or negative output growth in this fiscal year, they are borrowing more from banks to overcome current financial woes, bank executives overseeing credit demand say. Ongoing financing of China-Pakistan Economic Corridor (CPEC)-related projects have also led to higher private-sector credit. After the return of Prime Minister Imran Khan from his China visit, such financing is expected to gather more momentum, they say.

“Piled-up claims of export rebate claims of export-oriented industries also necessitate higher borrowings from banks,” says the chairman of the Pakistan Bed wear Exporters Association, Shabir Ahmed. “In the past two fiscal years, tens of billions of rupees had remained stuck with tax authorities on this account. Exporters are making up for this blocked source of funding from bank borrowing.”

Export growth in the first quarter of the current fiscal year and an increased cost of imported inputs have also led to larger export and import financing by banks. But as imports have begun to slow down, import financing requirements are expected to somewhat moderate in coming months.

The pickup in private-sector credit in less than four months of the current fiscal year is impressive, but it also includes banks’ investment in private sector’s securities and shares. Therefore, one has to look at credit disbursement to private-sector businesses (PSBs) to have a fairer idea of the banks’ response to credit demand.

In the first three months of 2018-19, banks’ net lending to PSBs shot up to Rs93bn against just Rs25bn in the year-ago period, SBP statistics reveal. The sectors where credit disbursement showed improvement included textiles, readymade garment manufacturing, leather tanning, consumer finance, construction and real estate renting and businesses. Senior bankers warn, however, that the increase in consumer finance is more attributable to hardship borrowings due to weaker purchasing power at a time of weaker rupee and high inflation in the economy.

The fact that lending to PSBs in July-September has totalled Rs93bn whereas lending to the entire private sector, including banks’ investment in the private sector’s securities and shares, in a little less than four months of the year has shot up to Rs165bn indicates two equally important things.

First, in the three weeks of October, the pace of banks’ lending to PSBs gathered further momentum. Second, their investment in the private sector’s securities and shares saw a phenomenal rise. “That is understandable given the fact that the KSE-100 index witnessed greater volatility, twice falling too sharply on bad news and speculations and then recovering grounds on good news,” says a veteran stockbroker. “Banks that have more advanced ways of predicting stock market behaviour make smart stock buying on such occasions,” he said.

“Going forward, the pace of banks’ lending to PSBs will depend a lot on when exactly the government shifts gears and starts borrowing from banks instead of the central bank,” opines the head of a large local bank. “Chances are that this will happen sooner than later because once we enter the IMF borrowing programme, the Fund will likely object to excessive borrowing from the SBP, which is always inflationary in nature and weakens the central bank’s fight against rising inflation.”

Inflationary pressures that remained strong during the first four months of this fiscal year are less likely to recede anytime soon, especially after the recent hikes in gas and electricity tariffs and the latest increase in domestic prices of fuel effective from Nov 1.

Published in Dawn, The Business and Finance Weekly, November 5th, 2018