ISLAMABAD, 3 May 2004 — Analysts in Pakistan are unsure whether interest rates in the central Asian state will rise or fall in the next few months as a conflict grows between the government and local banks. The government is calling for a cut while bankers push for a hike. This comes at a time when the central bank is easing credit expansion, mainly, by allowing banks to decide whether there is a charge in the margin on lending.

Commercial bankers feel that after reaching a historic low, interest rates will start inching up during the next few months. The average lending rate, according to the central bank, has already moved up to 5.30 percent at end-February from 5.02 percent the previous month, compared to 7.58 percent in June, 2003. Zakir Mahmood, president of the country’s second biggest bank, Habib Bank Ltd. (HBL), said: “Interest rates will increase this year, or at the start of 2005. There is no room for a further reduction in interest rates.”

The Pakistani government wants the rates down to around 2.0 percent from the existing current rate of around 5.0 percent currently offered by banks to boost economic. Finance Minister Shaukat Aziz has already increased the GDP projection for the current fiscal 2004 that ends June 30, from 5.3 to 5.8 percent. But, his aim is to see GDP in 2005 surpass 6.0 percent, on the back of a current upsurge in industrial output. Heavy industry has recorded a 14 percent growth in the past nine months.

The Ministry of Finance, last week, initiated a move advising all commercial banks to lower their lending rates to around 2.0 percent on blue chip corporations and industry leaders.

The ministry wants the rate cut to bring down the cost of production over a variety of industrial products. But, with 80 percent of all banking now in the private sector, the government realizes it does not have the same clout to enforce such rate cutting as it had previously. Since November 2002, the state bank has eased its monetary policy, and lowered the yields on government benchmark Treasury bills to below 2.0 percent.

They are also undertaking a number of initiatives to reduce the cost of doing business in Pakistan. The government has asked private industry to substantially upgrade productivity, deploy modern technology, improve quality of products to international standards in order to make their cost of production competitive, fetch better unit prices at home and abroad, and divert consumer choices from imported or smuggled goods to home-made items.

The government is focusing attention on providing cheaper credit to small and medium enterprises — the backbone of the Pakistani economy. It has asked the government-operated SME Bank and the private sector micro banks to provide cheaper credit, especially for installing new units.

The State Bank of Pakistan’s Policy Department issued a new directive to all banks this week, allowing them to decide on their own if they wish to charge a margin against lending to their customers. Their new notification on the margin says: “The banks are allowed to fix or determine the margin requirements on facilities provided by them to their clients for corporate, SME, and consumer financing, taking into account the risk profile of the borrowers.”

The new directive, freeing banks from sticking to SBP-fixed margins, has been welcomed by the banking industry and the business. It will help the banks expand credit to private sector and use their accumulated liquidity, while, at the same time, assist the economy to expand. In the nine months to March, the banks advanced a total of Rs.237 billion to the private sector up from Rs.101 billion over the same period last year.

Businessmen said, the move will help small borrowers in various fields, as well as exporting industries.

Mirza Ikhtiar Baig, banking affairs head of Federation of Pakistan Chambers of Commerce & Industry said the move on margins will help borrowers in “a big way,” but if the banks “misuse” the new arrangement, the benefits of the move may not reach borrowers.