Earning easy money

In FY23, the private sector’s net borrowings from commercial banks stood at Rs211 billion — just 5.5 per cent of the government’s net borrowings that totalled Rs3.84 trillion. During four weeks of FY24 (July 1-July 28, 2003), the private sector did not borrow anything from banks on a net basis; it rather retired about Rs173bn bank credit. On the contrary, the outgoing PDM government borrowed Rs760.7bn, according to the State Bank of Pakistan (SBP).

Will the interim government, installed to hold general elections across the country, keep an effective check on its borrowings from banks? Well, it will have to continue to borrow massively from banks just to retire old debts and run the day-to-day affairs of the government.

Will the private sector also start getting enough bank credit? That depends on how quickly and on what scale the demand for private sector credit picks up and, more importantly, whether banks find it feasible to increase lending to private sector businesses.

Currently, banks have enough deposits. In FY23, bank deposits grew 12pc year-on-year to a new historic high of Rs25.51tr. So, the availability of funds is not a problem. Parking of funds is.

Over the years, banks have grown accustomed to investing in government debt papers and bonds, ignoring the demand for credit from within the private sector

Over the years, banks have grown accustomed to earning easy money by investing in government debt papers and bonds. In so doing, they have long ignored a genuine buildup in demand for bank credit from within the private sector.

That is why banks’ investment to deposits ratio soared to 81.9pc in June 2023 from 76.4pc in June 2022, but their advances to deposits ratio stood at just 47.8pc in June 2023, almost unchanged from 47.8pc in June 2023, according to a Topline Securities report.

This is not the story of a particular year when economic growth is too low (like 0.3pc in FY23) or when it is higher than average (like 6.2pc in FY22). This is a long-established trend, well entrenched in the banking system. Banks are unwilling to go against this trend; business leaders continue to protest, but to no avail, the government is itself part of the problem, so it often chooses not to be part of the solution—and the SBP, too, mostly keeps watching from the sidelines.

During the interim government — and even during the next elected government — banks will surely continue to invest heavily in government treasury bills and bonds. The reason is that even if FY24’s ambitious tax revenue target of Rs9.415tr is met, the country will still face a huge fiscal deficit as the total expenditure is projected to remain at Rs14.48tr.

In its budget estimates, the PDM government estimated that the gap between Rs14.48tr and tax revenue of Rs9.42tr would be bridged through various measures, including (1) non-tax revenue of Rs2.96tr, (2) non-bank borrowings of Rs1.91tr and (3) bank borrowings of Rs2.86tr.

But targets of non-tax revenue (coming mostly in the form of profits earned by the SBP and other government-run entities) and non-bank borrowings (originating primarily from National Saving Schemes) are just too ambitious. Historically, governments have never been able to generate such massive amounts of money through non-tax revenue and non-bank borrowings.

At the end of the day, the government will end up exceeding its bank borrowings by a wide margin. And banks will be happy if this happens. That will help them continue to invest aggressively in treasury bills and bonds and earn cool returns as interest rates are high with little or no possibility of falling during this fiscal year.

The private sector’s borrowings from banks will rise compared with the last fiscal year, but it will hardly be enough to meet even half of the actual demand, and of course, this borrowing will be too costly as interest rates remain high with little or no possibility of interest rate falling.

What may prevent the central bank from easing interest rates despite growing demand from the private sector is that the little improvement we have seen so far in the external sector is just too small — and its sustainability remains under question. Easing interest rates at a time when inflationary pressures persist may further weaken the rupee.

During FY24, Pakistan was originally supposed to make external debt repayments of about $24bn, but it managed to seek debt rollovers of roughly half this amount from friendly countries, including China, Saudi Arabia and the UAE. This has halved the external debt repayment requirements for the entire fiscal year. That is why during each quarter, the country expects much less pressure on the exchange rate than it could have been without debt rollovers.

But it is not just the external debt repayments that dry up forex liquidity and weaken the rupee. Elevated imports bill amidst slow or no growth in exports and remittances do the same. The massive decline of 26.4pc in the goods’ import bill of July 2023 compared to July 2022 is nothing but the lagged impact of the import restrictions that remained in place throughout the second half of the last fiscal year (January 2022-June 2023).

This lagged impact is bound to start weakening. Import bills will start rising if not from this month or the next, surely from the next quarter. The rupee will then come under pressure. And the intensity of the pressure will depend on whether growth in exports and remittances can help mitigate the effects of the elevated imports bills.

The decision of the outgoing PDM government to spend about Rs80bn on remittances-boosting incentives in this fiscal year may or may not work well. That depends, among other things, on the country’s political stability level and how overseas Pakistanis perceive it.