IN a decisive move, the State Bank of Pakistan has cut its discount rate for short term lending to banks by two per cent to 10 per cent, reflecting the global trends and meet the urgent needs of the economy of a front line state in the war against terrorism.
The governor of the SBP, Dr Ishrat Husain, has voiced the hope the banks would reduce their lending rates proportionately to the borrowers. Earlier in July, the discount rate was cut from 14 per cent to 13 per cent and in August to 12 per cent. But most of the banks did not pass on the benefit of those cuts to the borrowers particularly investors.
Bankers say their lending rates are not determined as much by discount rates of the SBP as the rates they pay the depositors, the high cost of their banking operations and the large loss in income they incur due to the hefty loan default which instead of improving tends to get worse as the non-performing loans increase.
So the savings rate of the public sector banks is 6 per cent, while several small banks offer upto 11 per cent and more for long term deposits. But the depositors are skeptical of the commitments of such banks in a system in which too many small banks have failed or had been fouled up.
Earlier, the IMF was not in favour of lowering the interest rates to prevent the large outflow of money from the country. The IMF argued there was heavy pressure on the rupee as capital was flowing out of the country through the Havala system and hence the dollar was going up and up.
The best way to check such outflow was to raise interest rates within the country which should be far higher than what the interests rate the money going out would get abroad. That had some effect on stabilizing the rupee vis a vis the dollar, along with several other factors.
The interest rates in Pakistan are still pretty high compared to those of other Asian countries, except Turkey which has a 57 per cent short term rate. The short term interest rate in India is 6.92 per cent, while Singapore which has been hit hard by the global economic downturn has 1.15 per cent short term rate, Thailand’s rate is 3 per cent, Taiwan’s 2.9 per cent, and Malaysia 3.30 per cent.
The only country in the East which has as high an interest rate or higher than Pakistan’s is Indonesia with its numerous problems.
Dr Ishrat now says the export re-finance rate would be reduced from 12 per cent to 10 by December to boost exports and help exporters who have obtained duty-free access to the European Union markets from January, 2002.
Exporters needed this relief at a time when the cost of exports has risen following the rise in the electricity rates which increases their cost of production. And yet Wapda and the KESC are calling for far higher power rates to save themselves from bankruptcy.
The governor has also advised exporters to get their export re-finance in dollars at 5.5 per cent instead of in rupees at 12 per cent or wait for getting that at 10 per cent in December.
One of the reasons for the low interest rates offered by the banks to depositors is the high income tax on them, which was as high at 60 per cent and inclusive of the provincial and local taxes 70 per cent. Naturally banks had to make large profits to have reasonable net profits after paying the high tax. But now Dr Ishrat says the tax which was reduced to 50 per cent in the last federal budget, would be brought down soon to 35 per cent, the same rate as other corporations pay. And that should serve as a spur to reduce the lending rates and give higher rates to depositors.
The World Bank and the IMF have been pressing for effective and comprehensive banking reforms. And the World Bank has this week come up with a $300 million credit for the banking sector’s re-structuring and privatization project to assist the country with its on-going banking reforms. Pakistan, says the bank, is working to develop a competitive private banking system free from the interest of the vested interests and operating under a strong regulatory framework. It is also developing a more effective banking court system.
The World Bank says its main objective is to reduce poverty. Its cross-country empirical research shows that a sound and efficient financial system leads to higher economic growth by as much as 2 per cent. If that much growth can be achieved in a country whose current year’s growth target is 4 per cent then it can be a great achievement.
Meanwhile, in the last few years there has been as many as six bank failures, the last being the major National Development Finance Corporation, preceded by the Prudential Bank, the Bankers Equity, the Indus Bank, the Schon Bank, and the original sinner the Mehran Bank.
The banking reforms are to reduce the cost structure of the state-owned banks for efficiency and facilitate their sale, complete privatization of partially privatized banks, liberalising bank branching policy to enable private banks grow faster and increase their market share, reforming national savings schemes to integrate them with the financial market, and reducing tax on banks to attract private capital into the banking sector. The banking reforms will also facilitate loan collateral foreclosure to reduce the cost of default and expand the lending to lower-tier markets, including consumer lending, discontinue mandatory placement of foreign currency deposits by commercial banks with the central bank to prevent repeating the foreign currency deposit crisis and allow banks to place their deposits abroad and strengthening the central bank to play a more effective role as regulator and guardian of the banking sector.
The terms of reference the reforms are truly comprehensive. What remains to be seen is how well they will be implemented and how truly strong and assertive will the State Bank of Pakistan become and supervise the far enlarged private banking sector more effectively.
Meanwhile, there have been great improvements in the rupee - dollar parity. Following the rise in the exchange rate of the rupee against the dollar by 40 paisa on Wednesday while the buying and selling rates of the dollar at the inter bank rate on Wednesday was Rs 61.70/61.75 it was Rs 61.35/61.50 in the open market. The difference in the buying rates is 35 paisa for dollar and selling rate 25 paisa.
The easy availability of the dollars and the small demand for it has narrowed the difference to almost nil. Within a week the dollar has shed Rs 1.30 or more than two per cent of its value. And since September 11 it has depreciated by Rs 5.60 or 8.3 per cent. The expectation now is it may come down by Rs 3 to Rs 5 for a dollar or more.
Now instead of more money going out more money is coming in as some of the disillusioned Pakistanis return home from the West where they face hostility to Muslims. Visas are not often available for Pakistanis for visiting many countries. And since the Western countries are probing into the bank deposits and other financial assets of Pakistanis and others, Pakistanis are feeling uneasy about keeping large bank deposits abroad. And since they do not know what form the war will take eventually and how long that will last, the scope for the outflow of money from Pakistan is now small.
In addition, the exporter are selling their dollars before it goes down further and they lose money.
This is the kind of ideal state which the State Bank of Pakistan and the official economists had wanted to wipe out of the Havala market for receiving home remittance. If the open market rates are not far higher than the inter bank rate overseas Pakistanis may prefer sending their remittances through the banking channel. And when their total remittances are estimated as high as 3 billion dollars a year instead of the one billion dollars which come through the banking channel, the country can be a great gainer for that.
But exporters think they are losers for the fall of the dollar as they will get less rupees for their dollar export earnings. Until recently depreciating rupee was the principal tool for increasing exports though that was a self-defeating exercise after a while as the imported inputs which the export industries needed also came to cost far more soon.
A stable rupee is good for the economy and the exports eventually after the rupee had sunk far below the Indian rupee and even below the Bangladesh taka. Now, if in addition to the stable currency we have less capital going out and more of the remittances coming in through the regular banking channels, instead of the Havala, nothing can be better. This is an ideal combination to help boost the sluggish economy with its perennial low growth syndrome and increasing poverty.