THE private sector has been marginalised owing to the shift in the banks' lending strategy to cater to the government's growing appetite for funds.
Credit expansion to the private sector remains subdued. A slight improvement in the overall credit to the private sector in fiscal year 2012, compared with FY11, was primarily attributed to bank lending to and investments in non-banks finance institutions especially mutual funds, which then invested these borrowed funds largely in government T-bills. As a result loans to private sector businesses grew by less than one per cent during the year — the lowest growth rate since FY08.
With banks’ changed strategy, the weighted average overnight rate remained near the upper bound of the interest rate corridor despite continuous liquidity injections through OMOs. State Bank's Annual Report 2011-12 has noted that this downward rigidity in interest rates on the very short end of the yield curve was also visible in other market rates, including lending rates of commercial banks. Specifically, following 200 bps cut in policy rate, weighted average lending rates of commercial banks saw a reduction of 112bps to 13.1 per cent by June 2012, against 14.2 per cent in June 2011.
Given the government's large borrowing requirements, commercial banks had little incentive to reduce interest rate, and channel funds towards private sector. It also seems that banks were using liquidity from SBP for onward lending to the government. In practice, it makes sense for commercial banks to do so, as long as liquidity in the market is available at a rate lower than T-bill cut-off rate. A positive spread between cut-off rates of 3-months T-bills and of OMOs, allowed commercial banks to do this for most of the year.
In FY12, the stock of budgetary finance from the banking system grew by 46.1 per cent to Rs3.8 trillion. Within the banking system, commercial banks' lending for budgetary finance has substantially increased in recent years, including FY12. Not too long ago, in FY07, the stock of budgetary finance was 18.8 per cent of the private sector credit; as of end FY12, this ratio has increased to 62 per cent.
In addition to budgetary financing, government borrowing for commodity operations and bank lending to public sector enterprises, usually against government guarantees, have also led to a rise in banks' exposure to public sector. Although understandable from banks' point of view, the changing composition of their balance sheets is discomforting, as banks are moving away from their core activity of intermediation by ignoring the private sector credit needs.
On the face of it, the overall credit to private sector (CPS) grew by 7.5 per cent in FY12 — the highest YoY growth since FY08. However, the bulk of this credit went to non-bank finance companies (NBFCs), who predominantly used the funds to invest in government papers. Thus the non- bank holdings of government securities saw a rise of Rs360 billion. Loans to private sector businesses (PSB), on the other hand, grew by only 0.8 per cent during FY12.
Given the double-digit rate of inflation in recent years, loans to private sector businesses have been shrinking in real terms. Not surprisingly, the private sector credit to GDP has been on a continuous decline since FY07. There has been a similar decline in the investment to GDP ratio.
The factors responsible for this deterioration are: excess capacity in the manufacturing sector owing to persistent energy shortages; heightened security concerns that have pushed up the cost of doing business; issues and cost related to governance; and the government's growing appetite for credit.
Loans to the manufacturing sector grew by only 0.3 per cent in FY12, compared to 9.6 per cent to the previous year. The deceleration was broad-based, as a large number of industries, either paid off existing loans, and/or reduced their fresh credit demand.
Despite increased trade volumes and modest growth in wholesale and retail services, trade loans saw a net contraction of 6.9 per cent in FY 12 compared to an expansion of 16.5 per cent in the previous year. The demand for fixed investment loans has been low.
In this backdrop, a small increase in fixed investment loans during FY12 is a positive sign. The sectors responsible for this increase include consumer items, such as dairy products, beverages, road transport, and consumer durables. Fixed investment loans to the iron and steel industries also witnessed an increase, because of rising construction activity.
Looking ahead, SBP's decision to cut its policy rate by 250bps to 9.5 per cent is partially aimed at reviving private investment.It is expected to help consolidate the modest improvement in underlying economic activity seen in FY12.
In addition to this, the government has also amended the SBP Act 1956 to limit the flow as well as stock-of government borrowings from the central bank. Specifically, a limit of zero quarterly borrowing from SBP was explicitly included in the Act.The government is also mandated to retire its outstanding borrowing from SBP within eight years from April 2011.
It is too early to gauge the medium- to long-term impact of these changes in the Act The amendments, passed in March 2012, stipulated zero quarterly borrowing for the last quarter of FY12 that was not met.
However, the limit on government borrowing from SBP during the first quarter of FY13 was strictly observed. It was a positive development.