Why private sector credit off-

take remains low?

National Debt Conference 2015

Saturday, 12th December 2015, Marriott Hotel, Islamabad 

Masud Al Taj

Deputy DirectorDomestic Markets & Monetary Management

State Bank of Pakistan

Disclaimer

The views or opinions expressed in this presentation are solely those of the speaker and do not necessarily represent those of the State Bank of Pakistan. The State Bank of Pakistan does not endorse, and assumes no responsibility for, the content, accuracy or completeness of the ideas and information presented. The tables, graphs and text presented in this document should not be published without the consent of the author/speaker.

AgendaA. Background

B. Is the flow of credit to private sector low in Pakistan?

C. Has there been any improvement in the recent years? Is it good enough?

D. Why private sector credit off-take remains low?

i. What are the Demand-side issues?

ii. What are the Supply-side constraints?

E. Conclusion & policy lessons

Background

Role of private sector credit in promoting investment and economic activity can hardly be overemphasized in a developing country like Pakistan.

In a bank-dominated financial sector, commercial banks are a major source of funding for the private sector.

Bank-advances-to-GDP and real credit to private sector are key indicators that capture the importance of credit in economic activities.

Is the flow of credit to private sector low in Pakistan?

In Pakistan, banks’ credit to the private sector (as % of

GDP) has seen a decline since FY08, sliding from 27% in

FY08 to 13% in FY15.

This ratio is low for Pakistan among the regional emerging

economies.

In other countries this ratio surpassed the pre-GFC level,

when credit activities were at their peak; Pakistan faces a

decline.

Is it really that low?

The situation is not that bad

in real terms, as the declining

inflation has significantly

impacted private businesses’

borrowing pattern.

In fact, the real credit to

private sector is on a positive

growth trajectory since 2008,

and more so in the last 3

years

But the improvement

witnessed is not enough; the

flow of credit to private

sector remains low.

2014

2013

2012

2011

2010

2009

2008

2007

-20

-15

-10

-5

0

5

10

15

20

Flow of Real credit to private sector

Improvement: Yes

Is it enoug

h: No

Source: SBP, WB

Why Private sector credit off-take remains low?

A number of factors have influenced the credit pattern and

contributed towards low private sector credit off-take in

Pakistan. These include:

Demand-side issues:

1. Fall in Commodity Prices

2. Structural issues in Pakistan

3. Limited financial inclusion and awareness

Supply-side constraints:

1. A dominant borrower

2. High credit risk

3. Under-developed Corporate Debt Market

Why private sector credit off-take remains low?

Demand-Side Issues

Demand-side Issues: Fall in Commodity Prices A sharp fall in commodity

prices, domestically and internationally, have reduced the demand for bank credit.

Distribution of credit by type shows that the deceleration in FY15 was entirely stemming from lower working capital loans to private businesses.

However, working capital loans, adjusted for the fall in wholesale prices, indicate a growth of 8.9 percent during Jul-Mar FY15.

Fixed investment loans expanded by PKR. 84.4 billion during Jul-Mar FY15 (1.7 times of the expansion seen in Jul-Mar FY14)

Demand-side Issues: Structural issues in Pakistan

Structural issues (e.g., energy shortages, law & order situation, etc.) have dented investor confidence and forced businesses to operate below their optimal capacity in Pakistan, resulting in low credit demand.

World Development Indicators show that on average, firms in Pakistan faced 70 power outages during a month in 2014, compared to 65 in Bangladesh, 14 in India and 4 in Sri Lanka.

Demand-side Issues: Limited financial inclusion: Less than 10% of

registered firms in Pakistan avail financing from the banking system.

WDIs show low banking sector penetration in Pakistan; only about 25 out of 1000 adults borrow from the banks.

According to WDI, the new business density (new registration per 1000 people in a year) in Pakistan is just 0.04 compared with 0.09 in Bangladesh and 0.12 in India.

Firms using bank finance (% of total firms)

Country % Firms using bank finance

Srilanka 43

India 30

Philipines 22

Bangladesh 19

Pakistan 9

Source: World Development Indicators

Why private sector credit off-take remains low?

Supply-Side Constraints

Supply-side Constraints: A Dominant Borrower

The government has relied on financing from the banking system.

By limiting the pool of funds, the dominant borrower leaves limited space for the credit to flow to the private sector.

The share of government borrowing in total bank lending in Pakistan is rising since 2009.

The government borrowing from the banking system is high in Pakistan compared to selected regional economies.

However, as per the recent changes in the interest rate corridor mechanism, the central bank has assured liquidity at the policy rate as per the borrowing requirements of the government / private sector. This will ensure flow of liquidity to the private sector as and when required.

Supply-side Constraints: A Dominant Borrower Two main factors played key role in government’s heavy reliance on

the banking system:

Large fiscal deficits over the years required government to borrow more.

Limited access to international capital markets meant borrowing from external sources dried-up; forcing govt.’s to borrow from the domestic banking system.

To the government’s credit, these indicators have shown improvement in recent years.

Date Issue Type Tenor Amount (USD Millions)

Sep-15 Eurobond 10-year 500

Nov-15 Sukuk 05-Year 1,000

Apr-14 Eurobond 10-Year 1,000

Apr-14 Eurobond 05-Year 1,0002013 2014 2015

0.0

2.0

4.0

6.0

8.0

10.0

64.4

64.6

64.8

65

65.2

65.4

8.2

5.55.0

Fiscal Deficit & Public Debt (as % of GDP)

Fiscal Deficit (LHS) Public Debt (RHS)

Source: MOF, SBP

Supply-side constraints: High Credit risk

Banks have little incentive to extend loan to private sector on account of complex legal considerations and cumbersome repossession laws which creates high credit risk.

Supply-side constraints: Corporate Debt Market The relationship between corporate bond markets and economic

development has been widely recognized.

In an uncertain macro environment, banks are reluctant to advance long-term loans to the private sector.

In the absence of corporate debt markets, firms find it difficult to mobilize funding for investment projects.

Although increasing in size, the corporate debt market is still shallow in Pakistan.

99%

1%

Corporate & Govt. Debt Markets

Marketable Gov-ernment Securities

TFCs

Source: State Bank of Pakistan

FY95

FY97

FY99

FY01

FY03

FY05

FY07

FY09

FY11

FY13

FY15

 -   

 20,000 

 40,000 

 60,000 

 80,000 

 100,000 

Outstanding TFCs

PKR

Mill

ions

Source: State Bank of Pakistan

Conclusion & policy lessons

Both demand and supply side factors are responsible for suppressing private

sector credit in Pakistan.

Energy bottlenecks, security challenges, low commodity prices, limited

financial inclusion, etc. are hindering private sector’s demand for bank credit.

The demand for credit from government is an important factor that negatively

impacts banks’ incentive to extend credit to private sector; however, recent

changes in the IRC structure will ensure flow of liquidity to the private sector

Current situation provides an opportunity for private sector credit to take off

and improve Pakistan’s GDP growth path on account of:

Improvement in security situation

Increase in government focus on developmental projects (e.g. expected investment

under the China-Pakistan Economic Corridor)

Overall optimism on Pakistan economy

Conclusion & policy lessons

A developed and vibrant Corporate debt market is the need of the hour. Steps must

be taken to develop the corporate debt market in Pakistan.

The govt. should continue taking effective measures for addressing the demand-

side constraints e.g. law & order and energy crises, improving business

environment, etc.

The fiscal and monetary authorities, with the support of international donor

agencies, must continue with the agenda of improving financial inclusion and

enhancing financial literacy.

The govt. needs to continue with its efforts to reduce the debt levels in line with the

FRDL, mobilize cheaper funding from external sources and shift its borrowing

needs from banks to non-bank investors to create space for the private sector

credit.

Banks also need to take measures to diversify their credit portfolio as excessive

investment in government securities is hampering effective financial intermediation.

Thank You!