Will interest rates in Pakistan drop further?

ISLAMABAD - Will banks' lending rates charged to business and industry in Pakistan decline further - or will they inch up?

By M. Aftab

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Published: Sun 2 May 2004, 10:21 AM

Last updated: Thu 2 Apr 2015, 12:21 PM

The government is calling for an interest rate cut. But, the bankers are hoping for a hike.

There are moves on both ways. At the same time, the central bank is easing credit expansion, especially, by allowing banks to decide on their own whether they want to charge a margin on lending.

The Government of Pakistan (GoP) wishes the interest rates to decline further to around 2.0 per cent, from the existing typical rate of around 5.0 per cent that the banks are charging. GoP favours a rate cut in order to boost the economy. Commercial bankers, however, feel that after reaching a historic low, as of now, interest rates will start inching up during the next few months. All banks' average lending rate according to the central bank, has already moved up to 5.30 per cent at end-February from 5.02 per cent at end-January. But in June, 2003 it was 7.58 per cent. Zakir Mahmood, President of the country's second biggest bank, Habib Bank Ltd (HBL), just purchased by Aga Khan Group, says, "interest rates will increase this year, or in the start of the next year."

"There is no room for a further reduction in interest rates," he asserts.

The likely increase in interest rates will depend on the fact that as the economy picks up, availability of cheap funds will dry up, the bank liquidity will be reduced and interest rates will go up. The interest rate structure will also be affected if GoP borrowing from banks, for budgetary support, rises once more, and if US dollar interest rates - now at a 40-year low - start rising again, Mahmood points out.

But, the savers continue to get a raw deal at the hands of the banks, who have largely managed to enjoy good profitability and spread between the lending and the deposit rates. The average deposit rate is below 2 per cent.

Finance Minister Shaukat Aziz has already upped the GDP rate projection for the current fiscal 2004 that ends June 30, from 5.3 to 5.8 per cent. But, he will like to see GDP rate in 2005 to overshoot beyond 6.0 per cent, on the back of current upsurge in industrial output. The large scale industry has recorded a 14 per cent growth in the first nine months of the current year. It was possible because with the revival of the economy and increase in exports, a large number of industrial units have started operating at 70 to 90 per cent of their installed capacity. The production was boosted also because of the newly available and cheaper consumer finance that rose to Rs63.3 billion by end-December, 2003. Auto loans, of this, alone accounted for Rs20.1 billion. In case the GoP, State Bank of Pakistan (SBP) the central bank, and the commercial banks can slash the interest rate to around 2.0 per cent - and sustain it in a medium to a long term time scale, all concerned are confident that foreign and domestic investors will be positively attracted. The domestic economy, particularly industrial production, is looking up on the back of a low, and declining, interest rate environment, fuelled by high liquidity with the banks, but the FDI inflows have not been encouraging.

In order to attract FDI, Prime Minister Mir Zafarullah Khan Jamali, Investment Minister Dr. Abdul Hafeez Sheikh, and Petroleum Minister Nouraiz Shakoor, this week addressed several Investment Conferences in the Far East, including China and Hong Kong, besides recent bilateral contacts with Gulf and the Middle East.

Ministry of Finance (MoF), this week, initiated a move advising all commercial banks to lower their lending rates to around 2.0 per cent from blue chip, highly rated corporates, business and industry. Although in the last five years, the interest rate has declined from a historic high of 20 per cent to 5.30 per cent - and even to 3.0 per cent charged to big blue chip corporates, long-term investment has not picked up. This was coupled with the banks' reluctance to undertake risk and to commit for long term industrial financing because of their bad experience in the 1990s. The bank defaults then had reached a staggering Rs250 billion. The MoF wishes for a rate cut have been conveyed to commercial banks to bring down the cost of production of a vast variety of industrial products. But, the GoP realises that with 80 per cent of all banking now in the private sector, it does not have much of a clout to enforce such rate cutting. The SBP has, since November, 2002 been following an easy money policy, and lowered the yields on GoP bench-mark Treasury Bills (TBs) to below 2.0 per cent to signal that money should be available cheaply to business, industry and the consumers, otherwise the banks' liquidity will continue to unprofitably grow.

The GoP is undertaking a number of initiatives to reduce the cost of doing business in Pakistan. The GoP has also 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 focussing attention on providing cheaper credit to small and medium enterprises - the backbone of 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.

SBP's Banking 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. The SBP, so for, was itself setting the margins on various types of lending.

SBP, however, maintains its margin requirements on advances to term finance certificates (TFCs) and stocks and shares. Margins imply that the intending borrowers place cash, approved securities or commodity stocks as collateral against advances. SBP has now withdrawn its January, 2003 notification, specifying margin requirements for various categories of advances. SBP's new notification on 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 piled up liquidity, while, at the same time, assist the economy to expand. In nine months to March, the banks advanced a total of Rs237 billion to the private sector up from Rs101 billion in the like period of last fiscal. Syed Ali Raza, President of the state-owned National Bank of Pakistan, said, SBP decision will "give us more room to accommodate good clients. It will help us do more business. It will also provide an opportunity to good but small borrowers to get advances freely." 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 says 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. He proposed: "the banks should not calculate margins at the forced sale value of the assets offered as a collateral, and then also keep charging higher margins. The margins should be calculated at the market value of these assets. The banks should also stop adding up the markup or interest on advances beyond the approved tenure."

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