Market routs like the ’08 recession leave deep imprints in collective investor/observer psychology. Even though the term ‘credit crunch’ is not used as often as it was in the aftermath of Lehman Brothers’ collapse, it implied that the immediate effect of this particular downturn was complete drying of credit markets. The Fed/EMU decision to flood the financial sector with unprecedented liquidity banked on easing these credits markets, so banks could begin lending, subsequently stimulating investor activity, resulting in job creation and increased consumer spending.
That, as we have seen, was not to be. Every time a giant stimulus package was exhausted, banks were seen rolling back into the post ’08 risk-averse shell. That these cycles of central bank largesse invariably witnessed same pre-recession banker bonuses, which some quarters reacted to very strongly, is perhaps a topic for another occasion. But largely banks were able to convince governments of the need of continuous ‘quantitative easing’, that despite zero interest rates, if the money stopped flowing, the economy would stop working. And despite little empirical proof of the assertion, governments on both sides of the Atlantic seemingly bought into the argument.
In essence, the sovereign debt crisis in Europe is little different. Even though on the surface we read about peripheral governments’ inability to handle debt burdens, a phenomenon creeping into mainland Europe with frightening speed, the actual effort revolves around preventing Europe’s banks from collapsing. Some of the continent’s biggest banks have extremely high exposure to stalled debt, and the collapse of one can trigger a run on the entire banking sector, with catastrophic consequences for the financial elite that has had its way with policy makers for far too long. Whether or not the lot of the common man would change much in case of default(s) is debatable. Already, Europeans are subjected to harshest peace-time austerity. How a sovereign default can squeeze them further seems hard to justify.
There are important lessons for economies like Pakistan’s in the post-recession international banking saga. No matter how much one disagrees with the official handling of the credit squeeze in the west, it cannot be debated that a progressive market economy cannot function without solvent banks. And while for once our weak integration with the international financial system spared us the worst of the recession’s effects, we are still caught in chronic stagflation, and the depressed economy needs similar remedy. At such times, banks comprise the monetary intermediary that oils the wheels of economic expansion by leveraging private sector investment.
Unfortunately, Pakistan’s monetary policy over the last few years, coupled with static, risk averse banking, has severely wrongfooted crucial private participation. And the main culprit is reckless government borrowing. First, when interest rates were kept high to control inflation, government borrowing diluted the tight monetary stance, inflation remained high, and private sector offtake was discouraged. Then when rates were reduced, the government refused to cease borrowing, again crowding out private sector participation. The result has been too much money in the market (expect inflation to grow in short time), a weakening rupee (further aggravating inflation), and an unfortunate inability of private investment to create jobs and induce consumer activity. This way, there are no chances of the economy expanding beyond its unimpressive two per cent or so GDP growth. However, the government is not the only party to blame. Banks too have failed to exhibit responsibility expected of them, particularly after their impressive growth and diversification in the years following successful restructuring and privatisation. They are only too happy with the present situation, willingly facilitating government borrowing, since they provide the best, most risk-free advances the banks can make. This also exposes poor risk management, a banking sector feature held responsible for the epic collapse that plunged the entire international financial system in a tail spin.
Pakistani banks, and authorities alike, must not repeat mistakes that have prevented a coordinated bottoming out of the international downturn. Banks must make credit available to the private market. And the government must withdraw from the money market. At a time when the political/security situation has turned international investors away for at least the foreseeable future, the need for facilitating local investment cannot be stressed enough. And as much as the government, our banks must ensure our engines of growth are provided proper platforms to posture from.
T he writer is chief manager SME bank and a seasoned banker with over 30 years of experience