The private sector borrowings during July 1, 2004-January 1, 2005 at Rs285 billion have exceeded the overall fiscal year target of Rs200 billion. The target set for borrowings is not binding and State Bank encourages banks to meet full credit demand of the private sector.
It goes without saying that the regulators expect that the banks would make prudent lending to minimize risks in loan default. Banks are now generally better equipped to evaluate the lending risks, but they need to be more prudent in the areas that are new to them. Personal finance is one of them.
The share of personal finance in private sector credit in the first half of this fiscal year is not known but according to the first quarterly report of the State Bank released last month, net credit expansion during July-October 2004 was broad-based.
The report says that textiles sector remained the largest borrower adding that transport, communication and consumer credit also grew rapidly. In the last fiscal year when banks disbursed a record high private sector credit of Rs325 billion, the share of consumer credit was Rs75 billion or more than 23 per cent.
Whereas consumer credit involves greater risks of default, it earns higher interest income besides expanding the borrowers base. Higher interest income earned on consumer credit enables banks to continue cheaper lending to large manufacturing industries including textiles, cement etc.
In the last fiscal year, consumer credit was disbursed both for personal use as well as for purchase of automobiles and electronic household products. Bankers say the same is true for consumer credit off take in the first half of this fiscal year but data relating to this period would be out after some time.
They reckon that consumer credit off take during this fiscal year may touch Rs100 billion and overall private sector credit may touch Rs400 billion. SBP officials say that the trend seen during the first half of the current fiscal year suggests that full year private sector credit should reach Rs350 billion with consumer credit share of Rs80bn-Rs100bn.
Seasoned bankers say consumer credit in particular and overall private sector credit in general has been on the rise also because individuals and companies are borrowing money from banks to reinvest in stocks.
Stock brokers do not challenge this view. This explains the recent surge in the stocks value even amidst such disturbing news as eruption of attacks on Sui Gas Fields that attracted the world attraction but did not dampen bullish sentiments at bourses.
Individuals borrow from banks in tens of thousands of rupees under personal finance schemes to reinvest the same in stocks, particularly when the government offers such attractive shares as those of Pakistan Petroleum Ltd. through initial public offerings. But companies use bank credit for investing in stocks both directly and indirectly.
Bankers say some businesses borrow more than the required amount of money and invest a part of it in stocks: others, including those in the public sector offer higher dividends instead of using part of their profits to build up capacities and then borrow from banks to undertake business expansion plans.
When it comes to such state-run enterprises as Pakistan Telecommunication or the likes of it, transfer of higher dividends boosts the government's non-revenue income enabling it to reduce budget deficit and contain its direct bank borrowing.
This being thus suitable both for the government as well as for the state-run enterprises becomes popular-and as these enterprises pay higher dividends, the stock market attracts more investors and rises to new heights.
Low interest rates provide an enabling environment for all this to take place-and with weighted average lending rate still at 6.61 per cent (at end-November 2004), the gradual tightening of interest rates by the State Bank since July is yet to put a stop on the borrow- more-to-invest-in-stocks cycle.
A key reason for this is that whereas the gradual increase in treasury bills yields has led financial institutions to invest more in the bills than in stocks, it has not encouraged large corporates to follow suit.
Large corporates continue to get generous bank financing still at attractive rates-at the rates considered feasible by those who borrow from banks to reinvest part of that in the stocks or to enhance production capacities after handing out handsome dividends.
So, whereas higher credit off take not only helps the private sector's productive activity grow but it also enlivens the stocks market. The combined impact of the two should be favourable on overall economy but there are perils behind promises.
As discussed earlier, when private sector credit off take shoots up it increases risks of default on bank loans. SBP Governor Dr Ishrat Husain has already rung this alarm bell at a gathering of top bankers last month at the Institute of Bankers Pakistan.
No less important is the issue of mismatch in assets and liabilities tenures. When banks lend recklessly they cannot focus on assuring that they need to match not only the volumes of assets and liabilities but also their tenures-to the maximum possible extent.
This, from bankers' viewpoint poses more of a threat than the risks of default. If a bank keeps making say one-year loans and the stock of loans rises to say Rs100 billion, it is just prudent for that particular bank to keep with it one-year or longer-term deposits worth as much close to Rs100 billion as possible.
With the private sector credit rising too fast so far during this fiscal year, it is feared that many banks may suffer from mismatch in asset and deposit tenures. Such a mismatch could be dangerous as it complicates interest rates projections and affects banks' profitability.
It has also implications for the banking system as a whole. With the banking system exposed to a larger amount of long-term assets with smaller amount of deposits to back up the same, it is feared that the growth in assets cannot be sustained and as such interest rates for long term may have to be raised quickly.
Too fast a growth in private sector credit is also inflationary particularly if it is taking place in low interest rates regime because it encourages hoarding and inventory building of finished goods. To address this issue, whereas banks are required to make prudent lending, the central bank needs to ensure that average lending rates do not turn negative.
Till end-November average lending rate of 6.61 per cent was clearly negative as year-on-year inflation during that month was 9.26 per cent. But as yearly inflation did fall to 7.37 per cent in December and as average lending rate for December is supposed to be higher than 6.61 per cent, lending rate would be only nominally negative.
How soon the average lending rate would become positive depends on whether inflation would decrease in the months to come. The central bank has been walking on tight rope while tightening the interest rates to contain inflation but avoiding a sharper increase because that can depress growth.
But chances are that it would continue increasing the interest rates as indicated by increasing weighted average yield on six-month T-bills by 43 basis points in one go at the start of this month.
An inflationary impact of a higher private sector credit off take can be offset to a great extent if the share of agricultural lending is it is increased. Unfortunately, agricultural loans still make up a very small part of overall private sector credit.
In first five months of this fiscal year, farm credit disbursement under the State Bank's mandatory scheme totalled Rs34 billion or just one fifth of overall private sector credit of Rs163 billion.
Increased agricultural lending mitigates the inflationary impact of higher private sector credit off take by improving supplies of food items. The scarcity of food items causes food prices inflation and that in turn sends overall inflation figure still higher as food prices account for 40 per cent of overall inflation.
Higher prices of food items caused mainly by shortage of wheat had pushed up year-on-year food inflation to 13.56 per cent in November. Thanks to some improvement in food supplies backed by import of a million tonnes of wheat during July-December, the yearly food inflation fell to 7.88 per cent for December.
Higher disbursement of farm credit, coupled with a long-term policy for promoting the agriculture sector, can also be helpful in developing import substitutions and thus keeping imported inflation in check.
Besides, the boost it would give to the agricultural sector can be exploited to improve the lot of rural Pakistanis, most vulnerable to rising inflation, and to reduce poverty.
Large local banks with huge networks of branches across Pakistan can play a vital role in laying the foundations of agricultural credit marketing, so necessary for this purpose.