Pakistan is redesigning its strategy for economic growth with focus on private consumption that currently accounts for 80 per cent of the Gross Domestic Product (GDP).
“It is obvious that any move to boost private consumption will have a much larger impact on the GDP growth than any other measure”, say Dr Ishrat Husain, Governor of the State Bank of Pakistan (SBP).
Some skeptics tend to disagree. And Dr Ishrat Husain believes that, “their mindsets are still frozen in the traditional way of public sector and government-led growth supplemented by a corporate and industrial sector.”
Dr Ishrat carries strong conviction, and believes in pragmatic approach to achieve set targets and is an active participant in any controversy surrounding core economic issues.
Some economists say that in a developing economy and an emerging market, where capital markets are not fully developed, economic growth has to be led by the government spending in infrastructure. Official efforts have been mounted to develop the capital market so that public-private partnership could be forged to finance infrastructure projects and quicken the pace of economic growth. There are constraints on government spending.
So far, banks have lent to the government, corporates and trade. Now, the State Bank, the World Bank (WB) and its affiliate International Finance Corporation (IFC) are encouraging them to move into consumer financing.
Explaining his point of view, the SBP governor referred to the basic economic law for generating national income in any country—developing or developed— which stipulates that GDP= private consumption + private investment + public consumption + public investment + exports-imports.
Official figures show the share of various components in the GDP as follows: private consumption about 75-80 per cent, difference between export-import 5 per cent, total investment 13.2 per cent( in which the share of private sector is 62 per cent and the public sector is 38 per cent) and public consumption 8.2 per cent. The ratios change over time. In the past year or two, the contribution of private consumption to the GDP in the USA has ranged between 65-70 per cent.
In a key-note address on housing finance in Pakistan at a work-shop organised by the World Bank and the IFC last week, Dr Ishrat Husain described mortgage finance and auto-finance as, “key elements of private consumption that provide not only the backward and forward linkages to industrial and services sectors but also enhance the overall level of private savings.”
In his quest to obtain mortgage financing, the borrower has to save at least 20 per cent of the total cost upfront as down payment in the form of equity. In addition, he pays monthly instalments over and above the rental income to meet mortgage commitments. It helps the middle income groups to build equity in house building. It is lending-induced savings that boost domestic rate of savings.
The SBP and the commercial bankers are moving with caution towards consumer finance. During the quarter April-June 2003, gross disbursement by banks for house-financing has increased by Rs600 million, not a hefty sum. The housing finance work-shop was designed to acquaint bankers with the experiences in housing finance in Malaysia, India, Thailand and Sri Lanka.
Caution is necessary because consumer-focused growth in Argentina has been a failure. Addressing the Pakistan Institute of Development Economics in Islamabad last week, Professor Mariano Tommasi, director, Centre for Studies for Institutional Development, Buenos Aires, said:” For a time, it was a model, if the criterion is private consumption. As foreign debt mounted, this increased by 50 per cent during 1990-97 and then plummeted to the ground in 1998. By 2001, we were back to the point where we had started;poverty, unemployment, high disparity in income distribution.More than 50 per cent of the population now lives below the poverty line.”
Mortgage financing works against borrowers when they do not earn enough or banks charge exorbitant interest rates making it impossible to service their loans. Defaults have quadrupled in United States and so have repossession of mortgaged properties in case of some income groups. The borrowers should get affordable loans in a fast changing interest scenario.
Dr Ishrat wants that the government should allocate long-term funds mobilized under the National Saving Scheme, e.g.Defence Savings Certificates, in excess of budgetary requirements to the commercial banks for housing finance. The banks would thus save cost on mobilizing deposits and would be able to match long-term deposits with long-term loans. The benefit could be shared with the borrower.
Similarly, the State Bank wants Private Pension Funds to be set up expeditiously. Since the government is short of funds, these could be used for building infra-structure through public-private sector partnership. Once the district governments have built up their capability and improved their accounting system, municipal bonds could be floated for investment by pension and other investment funds for local infrastructure projects, says an official.
Here it would be necessary to guard against pitfalls and learn from failures and successes in other countries. Dwelling on experience in privatization of pension funds in Argentina, Professor Mariano Tommasi says”previously some people evaded their contribution and the government stole the money. Now, ten years later, we are worse. More people evade contributions, while stealing goes on.”
House financing is specially risky in an environment of falling incomes of middle classes and increasing unemployment.The eroding returns on bank deposits as a result of rapid and sharp fall in interest rates and the lower official inflation rate to which these rates are linked, is depriving middle income groups of incomes from supplementing their disposable incomes. Similarly, pension fund and provident fund management has become far more difficult as interest rates have plummeted.
If it is assumed that the return on bank deposits and National Savings Certificates has fallen by about 50 per cent,if not more, a banker says the small savers have been deprived of interest incomes of billions of rupees. It means impoverishing the savers.
Pamela Lamoreax, manager,IFC Housing Finance Group, has hinted that the IFC would look at the possibility of providing mortgage insurance and assistance for securitization of house loan. The Corporation has helped India set up a mortgage insurance company and Pamela would be discussing a similar proposal with local bankers.
In developed markets, banks have turned securitization of credit risk into a trillion dollar industry- an area which generates hefty returns. They sell their loans to insurance companies, investment and pension funds and get others to reinsure their risk. But questions are being raised by financial analysts about lack of transparency in which credit risks are being transferred as some portion of” structured” credit is not so liquid and encashable.
To quote the Economist, London,” the glut of corporate bankruptcies in 2001 and 2002 have had no devastating effect on balance-sheet of banks that might have been expected. Loans of $34 billion were wiped out in the bankruptcies of Enron and Worldcom alone. Yet only millions,rather than billions, are showing up in the quarterly reports(balance-sheets) of affected financial institutions..Where are all the losses gone?” That is one explanation why banks have not collapsed in prolonged economic slump in the United States.
Some fear is being expressed that” loans buried today, will show up in new places later, causing an unpredictable damage to the world economy,”says the Economist.
Policy makers in Pakistan look at the situation differently. Like any other business, they argue banking business makes profits and suffers losses. In credit risk transfers worth trillions of dollars, some billions of dollar loss is nothing to worry about.
The loans originate in banks after thorough appraisal. The package of credit risks is transferred to other financial institutions who operate on a long-term basis. For banks, it frees up the space for churning new business. The credit risk is transferred to those who have appetite for it.