This refers to the article published in your newspaper on Dec 22, 2003 regarding profitability of the State Bank. The writer has criticized the existing policy of market liberalization in favour of a more controlled regulatory stance and at the same time made some inaccurate inferences.
We respect the author’s views but disagree with his perspective. The philosophy that the writer has tried to propagate has been tested in various other economies in the past without any meaningful results. The policy of market liberalization, on the other hand, with relatively more dependence on market forces has remained the hallmark of many successful economies currently on the path of faster economic growth.
Market liberalization has helped more developing countries in the long run and the SBP will adhere to this policy stance. One needs to question the basic premise of the article. It is already well documented in the first ever SBP’s Performance Review that central banks, as opposed to commercial banks, do not direct their operations with the prime motive of earning profits. Moreover, any surplus profit that the SBP makes, is transferred to the government for budgetary support. It just so happens, that the policies pursued during the last few years that have resulted in an enviable built-up of foreign exchange reserves and acquisition of hard currency assets has directly benefited the government. At the same time, the rupee has also become a strong currency as 87.3 percent of reserve money is solidly backed by foreign currency holdings. In 1999 this ratio was only 29.6 percent. Dollarization was widely rampant and the rupee was being debased. Transactions were being conducted in dollars rather than rupees.
Today, the rupee has regained its importance as the medium of exchange. So, while the profitability of the SBP may have suffered as a result of pursuing these policies, the government and the country have been direct beneficiaries. The author therefore needs to take stock of the complete repercussions of SBP policies, rather than focus on a side effect of its policies, i.e. its own profitability.
Other consequences of SBP’s monetary and exchange rate policies pursued since 1999 include benefits in the form of competitive exports, reduced cost of government borrowing, a stability in exchange rate and as mentioned above, a significant rise in the foreign exchange reserves. The lending rates to businesses and individuals have dropped to the lowest levels ever and growth in private sector credit has reached unprecedented levels. Assets and Liabilities: The writer contends that ‘such a catastrophic fall in profitability can not be attributed to rupee depreciation nor to the decline in foreign interest rates’. It is evident that the writer is unable to distinguish between an asset and a liability position. A depreciating rupee would entail losses for a liability held in dollars, while an appreciating rupee would incur losses for dollar-based assets. Foreign exchange reserves of $11.7 billion in SBP’s books represent the asset side, while foreign exchange liabilities of $34 billion on the government exchequer represent the country’s liability position. Therefore an appreciating rupee would cause losses on the SBP books, but enable our liabilities of over $34 billion to be revalued at a rate that is almost 10 percent lower than the one applied two years ago. The country has gained tremendously due to the rupee appreciation even though the SBP may have booked a loss on its wider asset base of foreign exchange reserves. Fixed assets sales and provisioning: In a number of instances, changes in various heads of accounts have been interpreted on the basis of assumptions that are not entirely correct. For instance the assumption that the sale of fixed assets during 2002-03 was made with an underlying objective of showing profits for the year is not based on facts. The factual position is that these assets were sold as part of a policy decision taken in 1997 to dispose of fixed assets lying vacant where SBP was unnecessarily incurring maintenance charges. This is supported by the fact that in 2000-01 also the Bank had sold fixed assets despite the fact that profits from operations during the year were of significant quantum. Similarly, the assumption regarding the sale of investments is also contrary to the facts. The reasoning behind reduction in investments was the ongoing privatization of nationalized banks and not the intent of showing profits for the year. Since SBP holds 99 per cent shares in the nationalized banks, the privatization of these banks resulted in reduction of SBP’s investments along with gains. It would not be out of context to mention that during 2001-02 the provision of Rs3.1 billion in diminution of investment was on account of the privatization of UBL which was utilized during the year in review to cover the gap between its sale price and cost.
The writer’s contention that SBP’s provisions for loans and investments in current year declined by 80 per cent due to the fall in net profits is not correct for reason that since the adoption of IAS in 2001, SBP has made adequate provisions for loans and investments, thus, there was no need for further provisions. Foreign Exchange Transactions: The writer has severely criticized SBP’s activities in the foreign exchange market; particularly the maintenance of a high volume of foreign exchange reserves and their management. Firstly, it should be understood that building up of reserves was a deliberate policy measure and not an arbitrary act as portrayed.
The policy adopted by the State Bank, which the writer has bluntly termed as “ruinous” was quite instrumental in forestalling any undesirable trend. A higher level of reserves was able to keep the speculative market sentiments at bay; thus avoiding any undue pressure on the exchange rate; the country is now in a position to pay-off its expensive debts prematurely; a notion that was unthinkable only a few years back. Foreign Currency Placement and Deposits: these are always placed at positive yield levels. So, it is not possible to make a realized loss on that account. It is only because of our accounting convention, whereby we convert all our foreign exchange assets into rupees, that we have incurred a loss in a scenario of appreciating rupee and rising foreign exchange reserves. In accounting terms, these are translation losses due to conversion of foreign exchange reserves from dollars in rupees in which the SBP maintains and reports its accounts. If, for some unforeseen reason, the dollar-rupee exchange rate depreciates say once again to Rs60 = $1, the SBP’s accounts will show a profit of Rs25 billion (Rs 2.5 per dollar {i.e the difference between Rs60 and Rs57.50} x $ 10 billion in reserves). These profits and losses are unimportant. What is significant is the size of real assets accumulated.
The second source of lower profits arises because a large chunk of frozen foreign currency accounts have been liquidated. This means that the amount outstanding with SBP is now minimal and so the forward cover fee earned on that count has also reduced significantly. Furthermore, the liberalization of the foreign exchange deposit market means that SBP does not provide any fresh forward cover on new FE-25 deposits implying a further decline in the forward cover fee income. This decision was taken by the SBP to avoid the temptation, if any, in future to freeze currency deposits of residents and non-residents.
The argument that it was the lack of diversification in reserve portfolio that caused the losses is quite baseless. It is in fact a blessing that we have been running a short duration portfolio in an increasing yield environment. Otherwise we could have sustained capital losses due to increasing yields and declining prices.
Finally, the writer compares SBP’s losses with the Reserve Bank of India’s losses. It is assumed that India uses Indian Accounting Standards to revalue its foreign exchange portfolio whereas we are bound by the IMF to apply the International Accounting Standards to revalue our reserves. The key difference is that RBI takes its loss on revaluation as a notional loss rather than realized and as such it is capitalized. In Pakistan, we take it as a realized loss and provide a provision for it in our income statement. However, quite apart from these differences in accounting conventions, the fact remains that the foreign exchange management has led to a downward revaluation of our foreign currency liability and as such, the country is in a more advantageous position than it was a year ago.
Syed Wasimuddin,
Chief spokesman, State Bank