Pakistan is pushing hard to bring down the exorbitant interest rate to a single digit to boost investment and business.
The present endeavors are focused on bringing down the commercial interest rate ranging between 12 and 14 percent. The blue chip borrowers are charged between 11 and 12 percent. The average small borrower still pays around 15 percent interest. Some banks even charge upto 18 percent. Four years ago the rate was as high as 24 to 25 percent. But, whatever little reductions made by banks in the lending rate, were at the cost of cuts in the deposit rates for savers. This is in contrast with two to five percent interest rate in some of South Asian countries with whom Pakistan competes in the export field.
If the government, the central bank and commercial banks succeed in achieving their aim, it will be a major component that could shore up the economy, which has failed to look up for more than five years. High interest rates, coupled with high energy price, volatility of the exchange rate, input prices of raw materials and poor law and order situation are some of the elements business and industry cite for the stagnation and lack of new investment.
The State Bank of Pakistan (SBP) the central bank, has tried to ease the financial market. The foremost step is progressive reduction in the SBP’s benchmark discount rate by five percent from 14 to nine percent over seven months. The Treasury Bill (TB) rate has been lowered from 13 to below eight percent. In a related move, and in order to encourage general but particularly institutional investors, the SBP has launched the Pakistan Investment Bonds (PIB). The PIB yield is linked to the fluctuating TB yields.
The government has, however, failed to check energy prices including that of electricity and natural gas — both are state-produced and state-regulated, and both are the target of protest by business, industry and household consumers.
The energy prices has been constantly rising. The government, under the IMF directives wishes to raise them further “in order to bring them on par with international fuel prices.” In order to lower cost of imported raw materials — and capital goods — the government reduced, or entirely removed, customs duties on 4,000 improbable items in June, 2001 and 2,500 more just now.
The rate of tariff has also been brought down from 30 to 25 percent. This is aimed also at facing the global competition that the WTO operation will bring in. In view of this, slashing the interest rate is one of the most important issue.
“Banks and financial institutions must bring down the lending rate to a single digit, and reduce their cost of intermediation and the spread level, in order to meet the challenges of globalization. You should strive hard to bring the lending rates down to a single digit,” Finance Minister Shaukat Aziz asked the bankers across the country.
His advise follows findings of the “Pakistan: Financial Sector Assessment 1990-2000” report, prepared by SBP. “All banks must narrow down the gap between lending and deposit rates in order to boost economic activities in the country,” he says.
The government’s demand from banks is also justified is because it has lowered the 58 percent income tax rate paid by banks until June 2001 to 50 percent as of now. The present plan is to reduce it by around five percent annually.
Besides lowering the lending rates, the other thorny issue is the extremely low deposits rates that the commercial banks are currently paying to the depositors. In fact, SBP Governor Dr. Ishrat Hussain warns: “The profit rates are so low that these are hurting the savings rates, which is already one of the lowest in the world.” Some of the banks are paying as low as 3.8 to 4.3 percent profit — hardly a thing that will encourage people to save. This low profit rate is eroded further, and comes down to one percent or thereabouts, if the current official inflation rate of three percent is deducted. However, independent economists estimate the prevailing inflation rate to be as high as 7 to 8 percent. The government is projecting the inflation rate for fiscal 2003 that starts July 1, at 3.9 percent. That will almost mean a near-negative rate of return on deposits.
The reason for the present, large gap between the lending and deposits rates is due to high cost of intermediation, particularly of the nationalized Pakistani banks. These banks have high cost of collection that goes upto 5 percent. They have huge administrative costs and overstaffing at all levels. On top of that, their combined amount of non-performing loans that are overdue for payment for 90 days or more and the defaulted loans stands at Rs. 275 billion. Bankers claim the default adds almost two percent to the cost of intermediation. Following the reforms initiated in the banking sector in 1990, Aziz says that the outlook is optimistic. “The financial health of banks has improved as a result of the reforms, though it is still too meager. But, the banks should do better as a result of a tighter monitoring and supervision by SBP,” Aziz adds.
The general slowdown of the economy has already led to the closure of several Pakistani-based banks, as well as foreign bank branches, including those of the Bank of America, Hong Kong and Shanghai Banking Corporation, and Emirates Bank. They have either closed, merged or were acquired or purchased by Pakistanis banks. At least one major foreign bank is reviewing whether or not to continue its Pakistani operation. ANZ Grindlays Bank, the biggest and the oldest foreign bank operating in Pakistan with 18 branches, has been acquired by Standard and Chartered Bank. Small private banks like Schone Bank, Indus Bank and Prudential Bank have either closed down or merged.
“Small banks either must merge, or close down, because that is the way their financial health can be ensured,” says SBP Governor Dr. Hussain. Banks must upgrade themselves and follow what is happening on the global scene — strengthening of their balance sheets, mergers and acquisitions and consolidation. Some banks in Pakistan have failed for lack of adequate skill for liability management or their operations were not market-driven. They proved uncompetitive within years after the 1991 opening of the banking sector to private banks. Nearly two dozen private commercial banks were allowed to operate in 1990s.
Aziz has also warned the bankers against the pitfalls of money-laundering and “severe consequences” because Islamabad, like the world community, is now committed to anti-money laundering legislation. Islamabad plans to introduce, what senior Finance and Law Ministry officials say, “ tough legislation” to stop money laundering.
SBP and the government are also urging the banks to pay special attention to the liability side of their balance sheets. The past failure of the banks to do so meant losses. The government also had to inject huge amount of cash into some of the state-owned commercial banks in order to prevent them from going under.
The latest report by SBP on “The State of Pakistan’s Economy” in the third quarter of fiscal 2002 — January to March 2002 — notes that the lending rates are slowly coming down. It says “the weighted average lending rates on new disbursements by the banks during March, 2002 fell to 11.9 percent, from 13.2 percent in January, 2002, marking a cumulative decrease of 200 basis points since the beginning of fiscal 2002.