Credit contraction crowding out private sector

With mounting inflation pressures likely to remain a persistent threat in the foreseeable future, the government’s continued dependence on commercial banks for budgetary support and the latter’s risk averse behavior has begun to impact on the country’s economic growth. While bank credit to the central and provincial governments has ramped up sharply, the resources being committed to the private sector have contracted.
This flies in the face of conventional economic wisdom, which entails that the private sector is the engine of economic growth in both the developing and developed world. According to official data, the government borrowed over 80 percent or Rs278.12 billion more from the banking system during July-May 7 FY11 to finance a budget deficit of 4.5 percent or Rs783 billion sustained during the first 10 months of the current financial year.
The government’s borrowing during the period under review amounted to Rs 624.137 billion against Rs346 billion of the corresponding period in FY10. Further analysis reveals that during this period the government succeeded in arresting what analysts believe were growing inflationary loans from the State Bank estimated to stand at Rs213.283 billion. In andem, its borrowing from the scheduled banks skyrocketed to Rs410.854 billion during July-May 7.
Despite an apparent borrowing shift in the SBP’s stance, when compared with last year’s Rs165.4 billion, the government raised 29 percent or Rs 47.8 billion more from the central bank which has conceded on the need to cater to higher demand through the inflationary practice of printing fresh currency banknotes. With both official and unofficial economic observers warning against the negative trend, commercial banks appeared to greet the heavy reliance of the government that provides them with a risk-free and heavily-weighted investment window. At this juncture, the banks seem to have developed a state-centric tendency in terms of lending with their credit to the private sector depleting fast.
SBP figures for the same period show that the banks’ credit to private sector shrank by 13 percent or 17.3 billion to Rs112.8 billion against Rs130.18 billion of the corresponding months. On the other hand, banks have invested in the government’s risk-free papers, including Market Treasury Bills, Pakistan Investment Bonds and Ijara Sukuk, to the tune of Rs410.8 billion against Rs180.5 billion of the same period last year.
“The basic intermediation function of scheduled banks is being constrained as the fiscal deficit and the commodity operations of the government are financed by deposits at the cost of declining private sector investment,” observed the State Bank in its monetary policy decision last Saturday. Analysts, including the State Bank, believe that the resource-constrained government would have to diversify its budgetary needs to create some space for the private sector credit that through generating economic activity in the country would help the economy grow.
“The quantum of borrowing poses a challenge for effective liquidity management with implications for inflation in FY12,” said the central bank. It added that: “This will require government borrowing from the banking system to subside to create space for private sector credit.”