Risk management and operational efficiency of banks would be tested in 2013 as they may have to operate in a low interest rate regime that is expected to bring about uncertain movements in exchange rates.

The year 2012 saw significant changes in both interest and exchange rates: the central bank cut its policy rate by 250 basis points in three installments, yields on government bonds and treasury bills declined and banks’ fresh lending and deposit rates fell.

All this played a part in fuelling bullish sentiments in stock markets. National Saving Schemes also became more attractive and recorded an all time-high investment of Rs335 billion in eleven months of 2012.

Exchange rates too showed murkier movements. The rupee lost nearly eight per cent of its value against the dollar and at the end of the fourth quarter of this year it even came under a speculative attack as external sector weaknesses appeared more pronounced.

The depreciating rupee provided an impetus to export earnings and contained growth in imports particularly in the last quarter. As a result, the trade deficit narrowed down.

At this point of time, it is not clear whether the central bank would further cut its policy rate or it would put the rate on hold.

“But keeping in view the way SBP has been conducting its monetary policy we can assume that it won’t hesitate in chopping policy rate once again, presumably for the last time during this political setup,” suggested head of one of the top six banks. In mid-April review of monetary policy there would be a caretaker government in place to supervise the next general elections.

Economic growth concerns influenced monetary decisions in 2012 and this is not going to discontinue even in 2013, or at least during a large part of it, because clearing up the present fiscal mess would take time. “And unless the revenue to GDP share increases substantially, economic growth would have to be supported more through monetary easing than anything else,” opined a senior central banker.

“Though the increase in tax revenue to GDP ratio from the present is about nine per cent to say 10-11 per cent may remain elusive for some time, but the country is certainly moving in this direction,” a senior official of the ministry of finance. He cited recent efforts of Federal Board of Revenue to bring more people under tax net and to recover billions of rupees worth due from registered tax-payers. The official hinted that tax collection would surely get momentum once a caretaker government is installed. He also said a rising trend in provincial revenue, liberal inflows in NSS, some improvement in financials of state-run commercial entities like PIA and an anticipated cut in government expenses during the caretaker setup would ease fiscal problems to some extent.

In that case, it would be more prudent for the central bank to continue an easy monetary policy stance to spur economic growth and thereby provide additional impetus to tax collection. It would thus set the stage for the end of the current crowding out of private sector credit for an even faster expansion of the economy.

“Certainly yes, from our viewpoint this is how it should go along. I think if the process of monetary easing is halted anytime before the start of the new fiscal year in July, that won’t be good for the economy,” said a well-placed SBP source.

“As for the fallout of further easing on the interest rates on savings and investment ratios, one must appreciate that once economy starts growing around six per cent or more it’d be easier for the central bank to keep the policy rate stable without fearing any big negative impact on growth momentum. But all this won’t take place independent of the pace of inflation. If inflation comes closer to double digits once again, chances for which are slim though, monetary policy will respond to it.”

In other words, we can see more of policy rate cuts in 2013 if inflation remains within single digit. Many bankers also share this view. “But what is more important to see is whether SBP will continue chopping its policy rates bit by bit or go for one or two slashing throughout the year.

In either case, there will be pressure on lending and deposit rates but if the rate cuts come in piecemeal it’s good from the viewpoint of managing exchange rates,” said a senior executive of state-run National Bank of Pakistan.

External sector worries may slacken with sustained growth in exports, workers’ remittances and even portfolio investment, but “these worries won’t easily go because we’ll have to keep making huge foreign debt payments and as economy starts growing faster imports bill would become fatter.”

One worrisome trend that had emerged immediately after global recession and continued well into 2012 was that banks lent far less money to private sector businesses(PSBs) than they invested in non-bank financial institutions or NBFIs.

Between November 2011 and November 2012 banks’ investment in NBFIs expanded by Rs118 billion to Rs231 billion whereas their actual lending to PSBs grew by only Rs44 billion. “This is going to change in 2013. I’m quite positive on that,” insisted head of one of the top six commercial banks.

Three things are expected to embolden banks to lend more to PSBs. “First, in order to keep the share of spread income in their overall profits they need to lend more to earn enough money because the interest rates are down. Second, demand from private sector credit has begun to firm up in recent months particularly from such sectors as textiles, chemicals, agriculture, etc. And third, after making lots of money by investing in government papers, banks have become cautious about market risks of their overexposure to treasury bills and bonds.”

One of the market risks associated with this overexposure in a declining interest rate environment is that banks may not continue to make big money either through rollover of such investment in government bonds or treasury bills or through their secondary market trading.

The reason is that the rollover of investment also depends on varying government appetite for funds and the overall availability of liquidity in the market which has so far been kept excessively good by the central bank. And chances for earning quick bucks in secondary market of government bills and bonds are bound to become slimmer as their yields in primary auctions keep falling or remain flat.

Compared to this scenario, banks still have opportunity to earn decent return on their lending to PSBs. Bankers say the entire banking sector would not miss this opportunity though some banks may try to keep a low profile in corporate lending in a politically charged and uncertain atmosphere ahead of elections.