A few days before the PTI government came to power in August last year, the cut-off yield on three-month treasury bills was 7.75 per cent. One year on, it has risen to 13.75pc.
Exactly a month before the PTI came to power, the average yield on six-month bills was at 7.85pc. Now it is 13.95pc.
So it makes sense for commercial banks to lend excessively to the government. This will keep their risk-free interest income high. And that is exactly what they are doing. Banks’ romance with the government paper, however, is limited to three- and six-month tenors. During the last one year, they have not invested funds in one-year treasury bills. They don’t want to lock funds for a full year perhaps because they fear that confusion, U-turns and economic fire-fighting might land them in trouble.
Yields on three-year, five-year and 10-year Pakistan Investment Bonds (PIBs) also increased gradually from 7.5pc, 9.25pc and 8.49pc before PTI’s rule to 14.25pc, 13.80pc and 13.55pc, respectively, now. So banks are lending to the government through long-term bonds as well and the pace of lending is gathering momentum. In the first 40 days of the current fiscal year, the federal government borrowed from banks about Rs1.37 trillion. In the same period of the last fiscal year, it had retired Rs53 billion of bank credit.
But this excessive borrowing does not mean the government is splurging. It is, in fact, using the money borrowed from commercial banks to retire its debt from the State Bank of Pakistan (SBP). During the period under review, the government has retired Rs1.35tr worth of the central bank’s inflation-stoking debt.
Personal loans are growing noticeably as financial stress and high inflation have reduced people’s net income
The IMF required the government to reduce the stock of its borrowing from the central bank, which comes handy for every government as it simply means the printing of fresh currency notes. Excessive currency printing makes the rupee cheaper and fuels inflation. So the Fund’s advice was sane.
However, excessive government borrowing from commercial banks has a flip side. It makes banks lethargic. Being sure of having a secure source of lending open, they don’t bother to channel credit towards the private sector. Low demand from this sector and real or perceived fears of loan defaults provide banks with reasons, or excuses, to do it. But is this going to change? Is demand for private-sector credit going to increase now? Political uncertainty still persists though some quarters claim it will recede after Gen Bajwa’s three-year extension as army chief.
The national security situation has become all the more challenging after the Aug 5 Indian action in Occupied Kashmir. If the Kashmir conflict is handled through diplomacy and political uncertainty starts receding, the country’s economy can be expected to move forward. Private-sector credit demand will then take off though slower-than-anticipated global economic growth can affect the borrowing by export-oriented industries.
Currently, the private sector is busy retiring bank credit as it normally does during the first quarter of every fiscal year. But the pace of credit retirement is faster than that in last year.
During the first 40 days of 2019-20, the private sector made a net credit retirement of Rs104bn against just Rs18bn in the same period of 2018-19. The slump in large-scale manufacturing (LSM) has squeezed corporate profitability and, to add insult to injury, the cost of finance has gone up owing to interest-rate tightening. These are two key factors that have accelerated the retirement of corporate loans. Besides, alarmed by a rising loan infection ratio, banks have become too choosy in credit disbursement. (Net non- performing loans of all banks and development finance institutions as a percentage of their total advances shot up to 2.09pc at the end of June from 1.42pc at the end of Dec 2018).
At present, personal loans are growing noticeably as financial stress caused by slower economic growth and high inflation in the last fiscal year have reduced people’s net income.
Can the economy grow faster this year than 3.3pc of last year? The federal government and the central bank say inflation should begin to fall in a few months. The Economist Intelligence Unit said in a recent report that economic growth could reach 2.5pc — just a shade above the government’s own estimate of 2.4pc.
Inflation remains high (10.3pc in July). The number of taxpayers is growing, but the annual revenue collection target is too high to achieve. The release of the development budget is too slow, foreign investment is coming down, exports have started increasing but the volumetric gain is nominal, slippages in cotton output are imminent and industries are still struggling owing to depressed demand, higher cost of finance and political uncertainty.
Under this situation, government borrowing from banks can be expected to continue to grow while crowding out the private sector unless domestic consumer demand picks up. For banks, the real worry is how to lend more aggressively to the private sector without increasing the volumes and ratios of bad loans.
Published in Dawn, The Business and Finance Weekly, August 26th, 2019