UNLIKE commercial banks which mainly provide short-term working capital financing, development finance institutions primarily focus on financing development of long-term assets.
Another difference between them is that while banks usually cater to the needs of existing businesses, the DFIs help in setting up new greenfield projects, as well in balancing modernisation and replacement (BMR)/expansion of existing projects.
By the very nature of their operations, financing by the DFIs carries a higher risk as compared to financing by commercial banks.
The DFIs set up in Pakistan during 1950s and 1960s were instrumental in giving a boost to the private manufacturing sector, developing new entrepreneurs and setting up of industries in less developed areas. They also helped in rehabilitating sick or problem projects and in monitoring special loans provided by the government or foreign institutions.
Apart from promoting import-substitution industries, the DFIs assisted in capital formation through direct equity financing, as well as underwriting of public issue of shares and debentures of local companies.
They also assisted entrepreneurs in obtaining foreign investment, in formation of joint ventures and in arranging technical/managerial advice for businesses and industries. Up to the 1980s, the DFIs were by and large working smoothly and had made a valuable contribution to the country’s economic progress. However, subsequently many DFIs ran into problems on account of increased political interference, poor management, piling up of non-performing loans (NPLs), lack of resources, particularly foreign currency credit lines from international lending institutions.
The need of the hour and national interest demanded that the flaws of the DFIs were removed through restructuring and induction of autonomous professional management, so that the DFIs continued to play their positive role in the industrial development. After all you do not impose a ban on knives because they can be used to injure someone.
However, what we actually saw was an orchestrated campaign to discredit the DFIs concept itself and their dismantling either through liquidation or merger into commercial banks in a planned way, reportedly under pressure from the IMF and the World Bank.
The IDBP, the only remaining DFI which also holds a commercial banking licence, is presently not undertaking any significant industrial financing activity. SME Bank is not geared to finance large industrial projects. Leasing companies, with a maximum lease rental payment of five years, can play only a limited role in providing long-term financing. The enabling environment for a long-term bonds market also does not exist. Thus long-term sources for funding large industrial undertakings hardly exist for local entrepreneurs.
The above flawed policy, seriously affected industrial development owing to drying up of long-term sources of financing necessary to develop long-term assets. Moreover, in late 90s to early 2000s, the low market interest rates resulting from SBP policies, lured the consumer towards attractive consumer financing schemes floated by banks and other financial institutions.
Since most of the consumer products through bank financing were manufactured abroad, our policies helped in running the wheels of foreign countries’ industry while artificially raising the standard of living of the naïve domestic consumer. The inevitable happened and we have seen the collapse of consumer financing with massive defaults resulting from increase in interest rates.
Impact of closure of major DFIs: Impact of closure of major DFIs can be seen by looking at the share of manufacturing sector credit in total scheduled bank advances and comparing with the growth rate of gross capital formation in the years 2004-05 to 2010-11. These figures are given in tables 1 and 2 below, while growth rates of manufacturing sector and large scale manufacturing (LSM) are given in table 3.
The above tables indicate that owing to decline in credit to manufacturing sector because of closure of DFIs, fixed capital formation in the private sector manufacturing industry has been adversely affected. This is also reflected by a declining trend in the growth rates of manufacturing and LSM, with growth rates being negative in fiscal year 2009.
Table 4 presents data on scheduled banks credit extended to the LSM sector measured at constant 1999 – 2000 price (the finance and insurance sector deflator has been used for deriving this constant price series).
The credit to net output ratio has historically been high for large scale manufacturing – higher than for any other sector in theeconomy. Project and long-term finance has almost disappeared and banks advance only working capital loans and trade financing facilities. The collapse of the DFIs has very seriously hurt the LSM sector – not only has credit disappeared at the long end of the market, project evaluation monitoring and implementation capabilities have been drastically impoverished. New manufacturing sector projects – especially in the technologically intensive sectors – are virtually non-existent both because of project formulation and implementation capability deficiencies and because of non availability of long -term finance.
Table 5 presents data on gross fixed capital formation (GFCF) in the LSM sector measured in 1999 – 2000 constant prices as a share of total GFCF.
The table provides definitive evidence of continuing and accelerated deindustrialisation. Public investment played a crucially important role in establishment of technology intensive industries during the 1970s and 1980s – steel, automobiles, chemical, fertilisers machine tools etc.
The eclipse of public investment tantamounts to an accelerated de-technologisation of manufacturing. Foreign investors are not willing to ‘crowd in’ to the capital goods branches and the unavailability of long-term finance makes it impossible for the domestic private sector to do so.
A revival of public manufacturing sector investment is urgently necessary to increase the technological content of our manufacturing output and exports. Without this, we will continue to lose both domestic and export markets to foreign competitors.
Conclusions and recommendations : The relevant information and data show that in the past decade Pakistan has been continuously on the path of deindustrialisation. A major contributing factor in this has been the closure of the major DFIs. If Pakistan has to progress, the process has to be reversed. For this public sector DFIs must be revived, as private sector which is mainly motivated by profit cannot be expected to play this role.
Objectives like development of backward areas, infrastructure development, importing only appropriate technology for creation of maximum jobs, economic viability of new industrial projects etc. may not be priorities of the private sector.
In some cases these objectives might even conflict with private sector’s profit motive. However, learning from past mistakes, the DFIs must be run on professional lines, financing should be strictly on merit and their management should be truly autonomous and completely free from political pressures.
The writer is head of Finance & Accounting Faculty at the Institute of Business Management, Karachi
jamal.zubairi@iobm.edu.pk.