Behind the Scene : Falling Pakistan's economy and raising Banking sector

Economy:

In the H1-FY23 Pakistan perform poor on the economic front. There were some major concern lies such as, global economic condition, uncertainty surrounding the completion of IMF program’s 9th review, insufficient external financing and low level of foreign exchange reserve. There effects were double due to fallout of flash floods and political instability. Inflation rose to double digit, both agriculture production and large scale manufacturing (LSM) were contracted.

The State bank of Pakistan (SBP) and government of Pakistan (GOP) has made attempts counter the challenges. The SBP raise the policy rate by a further 225 bps in H1-FY23, on top of the 675 bps increase during FY22. Several regulator measures came into action to restrict the import. GOP curtails the federal expenditure on grants, subsidies and development.

High global commodity price internationally and some domestic factors pushed the national consumer price index (NCPI) inflation to 25% during H1 FY23 compare to 9.8% in the H1 FY22.? PKR depreciation along with increase in power tariffs and energy provided further impetus to inflationary pressure.

On the revenue side, tax administration efforts, inflation and higher return on deposit led to an expansion in FBR taxes. However, due to cut in import and overall dip in economic activity constrained tax collection below the target for the H1 of FY23.

The GOP faced the challenges to attract the foreign exchange inflows. Therefore, they relied on domestic banks and non banks source to meet the borrowing requirement through medium term floating rate instrument. Private sector credit (PSC) growth in working capital loans weakened significantly amid economic slowdown.

On the supply side, supply chain remained disruption resulting from Russia – Ukraine conflict and china’s zero covid-19 policy hampered global demand which also down the Pakistan’s export performance. Worker’s remittance also declined. It was noted that increase in use of informal channel of remittance flow due to global economic slowdown. ?

Performance of Banking Sector:

The banking sector of Pakistan showed a remarkable result in H1 of FY23 which lead to soaring income and profitability.

The income of banking sector mainly derived from interest. Rise in interest rate by SBP cause the ensured a steady flow of interest based income for the banks.? Most banks witnessed double digit year of year growth in their interest based income.

The balance sheet of the banks reflected robust growth in deposit with double digit year on year increase by most of the banks. The larger financial institutions with massive branch network and well established brand names, attracting a larger customer base due to zero cost deposit. These current accounts represent zero cost deposit as they do not require interest payment to customer. In the ongoing high-interest rate environment, zero-cost deposits hold significant value for banks. These deposits serve as the Holy Grail for banks as they can utilize them for lending purposes or invest them in government securities. Both of these options generate interest income for the banks, contributing to increase in profitability and overall financial performance which explains the astounding increase in income.

The banks have the opportunity to utilize their deposit in two distinct ways, by extending loans to individual and business or by investing in government securities and bond. The advance to deposit ratio (ADR) measure extends of lending to private sector including both business and individual of the total deposit held by the banks. Conversely, the investment to deposit (IDR) reflects the proportion of a bank’s overall investment in comparison to its total deposit. As a result of this inclination, the average ADR in Pakistani banks stands at 51%, while average IDR is notably higher at 71%.

Furthermore, the ADR experienced a decline below the 50% threshold in Q1 2023 as compared to Q4 2022 following the reversal of an additional tax measure.?

In July 2022, the government imposed a heightened tax on banks’ income derived from investments in government securities.?This tax?was supposed to be applicable in 2022. This tax amendment introduced steep tax rates of 55%, 49%, and 39% for banks’ investment income based on their gross ADR falling within the ranges of up to 40%, 40-50%, or over 50%, respectively. Consequently, banks were compelled to raise their ADRs above the 50% mark to mitigate the impact of the tax burden.

However, in late February of the current year, the government rescinded the tax amendment. With this reversal, banks are now only liable to pay the regular tax rate of 39% along with an additional 4% super tax. Without the ADR-based tax in effect, banks now have the freedom to invest in government securities, while the government can readily access substantial funds through borrowing from banks. This strategic move is expected to further hinder lending to the private sector. Consequently, gross ADR of prominent banks such as HMB, NBP, BAFL, MCB, and UBL has dipped below the 50% threshold.

Sources:

1.Report of State Bank of Pakistan on State of Pakistan Economy

2.Article of Profit Pakistan