''Demand for credit by private sector may remain weak''

The demand for credit by the private sector could remain weak despite cut in key interest rate followed by the infrastructural bottlenecks, poor law and order situation and uncertainty on the political front.
The State Bank of Pakistan in its Monetary Policy Statement on Saturday revealed that a declining interest rate environment has put pressure on banks to increase their exposure to the private sector as opposed to just placing their funds in the risk-free high-yielding government securities.
This is because as their return from government securities declines on the margin, they will have to compensate it from other sources to avoid reduction in their profits, thus, there may be an incremental improvement in the supply of credit to the private sector, according to MPS.
"First, given the infrastructural bottlenecks such as energy shortages, unfavourable law and order conditions, and an uncertain political environment, the desired boost in business confidence and thus private investment demand may not take place, resulted, the demand for credit by the private sector could remain weak despite interest rate reductions" the MPS pointed out.
Second, government borrowings from the banking system remain substantial and have remained largely unresponsive to interest rate changes. Banks are, therefore, likely to continue to avoid lending to the relatively risky private sector. In addition, the rising Non-Performing Loans (NPLs) are already deterring banks to increase their exposure to the private sector.
The year-on-year growth in Private Sector Credit (PSC), on the other hand, is only 6.3 percent. In flow terms, the PSC expanded by Rs 283 billion in Q2-FY12, which is historically the highest flow of credit extended to the private sector in a quarter.
This extraordinary expansion in PSC can partially be explained by a delay in cotton arrivals to the textile sector. The cotton arrivals to the ginners usually begin in the month of August or September, but this year the season began in October.
Despite substantial credit flow in Q2-FY12, cumulatively the PSC expansion in H1-FY12 was limited to Rs 193 billion, as there had been more than usual seasonal retirements in Q1-FY12.
One possible explanation for limited expansion in PSC in H1-FY12 is better corporate profitability in FY11, which facilitated repayments or kept the demand for fresh credit low, the MPS noted. An analysis of the detailed private sector credit data reveals that loans to private sector businesses have not followed the overall trend and in fact was less than half of the total extension of credit to the private sector.
A major part of credit belongs in the ''others'' category that includes credit to Non-Bank Finance Companies (NBFCs) and some Public Sector Enterprises (PSEs).2 Moreover, all of the fresh credit disbursement was utilised to meet the working capital requirements.
According to statement, the credit for fixed investment, on the other hand, has contracted by Rs 12.4 billion during H1-FY12. This reinforces the view that the primary factors for low credit demand for fixed investment remain the infrastructural bottlenecks such as energy shortages, unfavourable law and order conditions, and uncertain political environment.
In addition, the utilisation of installed capacity in major industries is considerably low and continues to decline, which explains low investment in the economy. The declining investment was one of the key considerations for SBP to ease its monetary policy stance in H1-FY12, given that inflation was expected to fall within its target for the year.