ISLAMABAD, 17 November 2003 — Banks operating in Pakistan are projected to continue enjoying good profitability during 2004.
This will come on the back of a good profitability in 2003. The State Bank of Pakistan (SBP), the central bank, has just described banks’ profitability as “an exceptionally good” in 2003. This is in sharp contrast to earlier forecasts of a profitability decline because of a continuing low-interest environment.
“Fiscal 2003 was an exceptionally good year for the banking sector, as important banking indicators witnessed a further improvement over fiscal 2002.” Deposits of the banking sector grew by 19.5 percent or Rs.275.1 billion over the already strong double-digit increase in the preceding two years. “This impressive deposit growth was driven by the unprecedented increase in overseas Pakistani workers’ home remittances, which reached $4.2 billion during 2003 — the highest one-year accumulation in the history of Pakistan,” it says. But it must be remembered that the inflow also included one-time remittances comprising, what Finance Minister Shaukat Aziz calls, “a reverse flight of capital.” The reverse flight was ignited not only by 9/11 and the US-led monitoring mechanism that is now in place at several places including Dubai, Singapore and other capitals, but also boosted the dollar supply in the Pakistani kerb and interbank markets. It lead to a 10.9 appreciation of the rupee, during 2002 and 2003, as the greenback went down. The fact that some of remittances were a one-time phenomenon is acknowledged by a reduced budgetary projection of $3.6 billion in 2004.
A strong deposit growth, coupled with SBP’s easy monetary policy stance kept rupee lending rates under “intense pressure through 2003. As a result, the weighted average lending rates slipped to single digits for the first time since 1974.
But at whose cost did it happen? The answer is depositors and savers, and that too in a country where savings rate is one of the lowest in the world. In order to fend for the reduced lending rates, and maintain their own profitability intact, the banks slashed deposit rates. As a result, the weighted average lending rates went through a steep slide of 454 basis points to 7.6 percent. The average weighted deposit rate for savers dipped to 1.9 percent, which means a negative return to savers because inflation rate is around 4.0 percent. Atrociously low profit rates to savers narrowed the banking spread by 227 basis points.
What was pushing the interest rates cut? The unusual interest rate movements in 2003 are “explainable entirely through SBP policy. Not only was SBP injecting more liquidity into the interbank market through its forex market operations, but its sterlization of these interventions were also smaller. Despite the relative stability of the discount rate, interest rates weakened considerably until (a) the net injections into the interbank market due to SBP’s forex operations fell sharply in the final quarter of the fiscal, sustained negative real primary yields on all short tenor guilts, and (c) the narrowing spread between rupee and US dollar raised expectations of a rebound in the domestic rates.” The exceptional liquidity injections, and the trend decline in interest rates also explain the surge in market interest for government paper as commercial banks sought to lock-in relatively high yielding assets, ahead of an anticipated decline in interest rates.
This was particularly evident in the rising speculative interest, specially on longer-tenor instruments — which offer greater gains as interest rates decline. It forced a flattening of the yield curve as government’s Pakistan Investment Bond (PIB) yields dropped to record lows.
SBP persisted with its easy money policy. At the same time, there was substantial boost in the annual external account surplus. It kept the money market highly liquid. Although the net government borrowing from commercial banks rose a substantial 28.9 percent and what SBP calls “ a stunning 284.9 percent rise” in private sector credit, could not chain-in a downtrend in interest rates that started in 2002. The weighted average auction yield for the benchmark 6-month Treasury Bills (Tbs) fell 463 basis points in 2003. It pushed the total decline in 2002 and 2003 to 1,090 basis points.
What dominated the monetary policy? It was “the exceptional growth”, as SBP describes it, in Net Foreign Assets (NFAs) due to external account surpluses. “Broadly, it can be argued that it was the exchange rate, which effectively constituted the nominal anchor for monetary policy during 2003.
In 2003, responding to the continued weakness in net private sector credit take off, the central bank increased market liquidity by substantially reducing the sterlization of its rising forex purchases and then reduced the discount rate in November 2002. “As a result, domestic interest rates plunged to all-time lows.” “This supported a revival in economic activity and, eventually, contributed to the stunning Rs.167.7 billion net private sector credit expansion,” SPB says. But, all said and done, the overall revival still is weak, partly because of political uncertainty but mainly for lack of entrepreneurial slackness.
Contrary to the fast, and dominating growth of NFAs, net domestic assets (NDAs) stayed subdued. What caused it? The government reduced its borrowing from the banks for its budgetary support, as more fiscal space was available to Islamabad following better tax collection, greater non-bank borrowing, and larger aid inflows. It, in fact, retired Rs.56 billion net credit.
Its net borrowing in 2002 was Rs.14.3 billion. At the same time, the “commodity operation loans” annually raised from the banks to buy and support major farm commodities, recorded net heavy retirement — offsetting “much of the phenomenal rise” in net credit offtake by the private sector. The growth in the net private sector credit offtake during the first four months of 2003, stayed below the like period of 2002.
But with the discount rate cut in November 2002, the net credit growth recorded a “spectacular uptrend.” A part of this increase was due to a sharp jump in trade-related — or foreign currency loans, higher working capital requirements, and increasing consumer credit. The industry, principally textile manufacturing was the key borrower.
The year also saw some cleaning up of bank balance sheets. The outstanding amount of Non-Performing Loans (NPLs), or defaulted advances, of all banks declined to Rs.227.7 billion at the end of 2003, down from Rs.234.7 billion in 2002. The NPLs to gross advances and net NPLs to net advances ratio witnessed a decline, indicating a reduced burden on account of NPLs.
The positive prospects for 2004 are already indicated by banks’ performance in the first quarter — July to September. By end of first quarter of 2004, bank deposits rose to Rs.1,734.43 billion, compared to Rs.1,474.05 in the like quarter of last year, as overseas Pakistanis’ home remittances and aid inflows continued substantially. This is inspite of a 15 percent decline in remittances in the quarter when these were $906.48 million, down from $1052.89 million in the like quarter of last year. Advances rose to Rs.1,051.18 billion up from 930.87 billion. The stock of investments was Rs.804.12 billion, up from Rs.601.58 billion.
SBP estimates, total investment rose by 16.2 percent in 2003, showing “the strongest rise in the last six years,” compared to an “anemic 0.4 percent” growth in 2002. It means total investment to GNP ratio rose to 14.8 percent from 14.6 percent in 2002. Most of the increased investment took place in the reluctant private sector, raising its contribution to 14.4 percent in 2003 — up from 6.2 percent in 2002. If that trend — though still weak, while looking at the stagnation of nearly a decade — strengthens, profitability in most fields, including banking, will move up.