The average interest rate spread — or the gap between average lending and deposit rates — shot up to 586 basis points in October from 334bps a year ago.
Fresh average lending and deposit rates of banks rose to 13.67 per cent and 7.81pc in October, respectively, from 8.81pc and 5.47pc last year.
The decision by the State Bank of Pakistan (SBP) to leave the key rate unchanged at 13.25pc in November was not without wisdom: recently released Pakistan Bureau of Statistics (PBS) data shows that annualised CPI inflation jumped to 12.7pc in November from 11.4pc in October.
This jump in the national average is too high. It indicates that underlying inflationary pressures are too strong. Containing those inflationary pressures within a month amid a weaker-than-anticipated fiscal performance and growing political uncertainty may prove too difficult.
In all probability, the inflation number for December will also remain high even if it does show a modest decline. While reviewing its monetary policy in the second half of January 2020, the central bank will rely on the CPI inflation number of December. It will also rely on inflationary pressures prevailing at that time. One of the most reliable indicators of such inflationary pressures will be the inflation for the poor, measured every week with the Sensitive Price Index (SPI).
The credit risk of banks is on the rise because the private sector is finding it difficult to repay past loans
Should we expect that the annualised reading of SPI inflation in the first or second week of January will show a steep declining trend — steep enough for the SBP to believe that it will have a desired impact on CPI inflation? Prudence demands we should not. Annualised SPI inflation is galloping: it went up from 14.7pc in September to 15.1pc in October — and surged to 20.2pc in November.
For the central bank, the genesis of maintaining a tight monetary policy in January is in the making. Banks are, therefore, well-assured that the banking spread might remain as high as it was in October, allowing them to continue earning high interest incomes.
According to a recent report by Topline Securities, cumulative profits of publicly listed banks rose 48pc year-on-year to Rs45.5 billion in July-September. Of that, 33pc originated from net interest income and 17pc from non-interest income.
The rising banking spread and higher interest incomes amid the chances of continuation of a tight monetary policy until the time inflation does not start falling is a good omen for banks.
But for productive sectors, this is bad. Business leaders have long been saying this and now independent economists also insist that inflation is no more demand-driven. Or, at least, it is as much cost-push as demand-driven. The average lending rate of banks on fresh lending stood at 13.67pc in October. This means a large number of industries and all consumer finance seekers were getting fresh bank finance at an even higher rate. This is crippling for industrial growth.
It is little wonder then that banks’ credit to private-sector businesses recorded a net contraction of Rs52bn between July and October, data released by SBP shows. The large-scale manufacturing output posted a 5.91pc year-on-year decline in July-September.
Minutes of the SBP’s Nov 22 monetary policy committee meeting are yet to be made public. But it was mentioned in the minutes of the Sept 16 meeting that an increase in the weighted average lending rate of banks and a higher risk premium had contributed to lower credit demand. In September, too, the SBP had left its policy rate unchanged.
The credit risk of banks is on the rise because the private sector is finding it difficult to repay previously taken loans. Volumes of non-performing loans (NPLs) are growing. But choking the lines of fresh financing to all categories of NPL owners is not wise. The SBP can ask banks to lower the interest rate spread for a majority of borrowers. Central banks can and actually do this. In May 2018, Bangladesh Bank, the South Asian nation’s central bank, had made it mandatory on banks to limit their interest rate spreads to 4pc to all borrowers, except for credit card users and consumer finance seekers.
Instead of rationalising their interest rate structure and searching for new private-sector customers, banks continue to invest heavily in government debt papers. Between July and October, they made a net investment of Rs428bn. As for the government, seeking more investment from commercial banks in treasury bills and bonds is better than borrowing from the SBP. That is exactly what it is doing under an agreement with the IMF because borrowing from the central bank is outright inflationary.
So things are getting complicated. The government is borrowing more from banks to skip inflation-fuelling borrowing from the central bank. Banks are lending excessively to the government and don’t bother to find ways for lending more to the private sector.
One reason for their reluctant lending to the private sector is that NPLs burgeoned 23.15pc in 2018-19 to Rs768bn. Stocks of NPLs are expanding because industries are in problem. Their cost of inventory is rising and sales declining. Consequently, they are cutting output and jobs.
The negative industrial output is resulting in the less-than-targeted collection of tax revenues. That, in turn, is compelling the government to borrow excessively from banks. How quickly recent gains in the external sector — higher foreign investment in treasury bills, a rise in exports and a fall in imports — can help the government minimise domestic borrowings is yet to be seen.
Published in Dawn, The Business and Finance Weekly, December 9th, 2019