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The central bank marked the beginning of Q4 of fiscal year 2023 by raising the policy rate to 21 percent. With a reset in borrowing rate at the beginning of calendar quarter, the average markup rate on commercial loans to private sector will now climb above 22 percent, its highest level in at least three decades. Naturally, this dangerous escalation in financing cost has raised fears that firms across the real sectors of the economy may soon begin to struggle in meeting debt obligations, as demand side is also battling severe inflationary pressures amid a historic decline in real wages. Are commercial banks truly on the verge of witnessing a massive uptick in over dues on loans to the private sector?

Not so fast. Some oft-censured trends in private sector borrowing may after all help protect commercial banks from being subjected to a massive cycle of provisioning on loans and markup repayments. Over the last decade, the credit profile of private sector borrowing has undergone massive and often overlooked shifts, that warrant deeper attention and comment. In this first of a series of research stories, BR Research looks at the changing profile of private sector debt (to non-financial sector) by taking a deep dive in private sector credit data dating back 10 years.

Since 2013, loans to private sector firms have undergone at least two major shifts. First, private sector borrowing has seen a significant change in maturity profile of outstanding debt, with the share of loans outstanding within 1-year tenor declining from a peak of 70 percent to under 60 percent today. This is shaped by a concurrent second shift in private sector debt profile: share of concessionary finance – loans extended to private sector firms where markup is subsidized/refinanced by the central bank at below policy rate levels – has increased from 7 percent in 2014 to 20 percent today. Add to this a third (and, a relatively better known) trend: the abysmally low share of SME (small, and medium-sized enterprises) in private sector loans, which has dropped from its peak of 15 percent in 2007 to less than 7 percent today.

Put together, what do these three trends mean for the financial stability and soundness of private sector debtors. First, that even as markup rates on fresh lending to private sector firms’ balloon, a greater share of outstanding credit with the private sector remains unaffected, as at least one-fifth of this borrowing has taken place at a lower than policy rate. But more significantly, a higher share of this concessionary finance (than in the past) has been locked-in at ultra-low markup rates in long term loans, meaning that the borrowing on fixed rate will also remain indifferent to the hikes in the policy rate. But most importantly, over 93 percent of lending to the private sector – including the concessionary financing loans – are to large corporates that are financially sound and well-capitalized; and shall not come under significant debt stress even if borrowing rates rise further.

These trends are remarkably perverse, of course. First a concurrent decline in share of SMEs even as cheap loans to the private sector soared shows that the concessionary finance bonanza of the last 10 years disproportionately – and almost exclusively – benefited business groups that are already well-served by the financial sector.

Two, while share of long terms loans (for fixed investment) rose from 32 to 38 percent, share of concessionary loans within LT lending grew at a much faster rate – from 5 percent in 2013 to 25 percent by 2022. This may indicate that while capital expenditure did take-off due to concessionary lending to some extent, the schemes in simply helped re-price planned investment (or investment that would have taken place without concessionary loans anyway, possibly at higher commercial rates).

Lastly, a decline in share of working capital loans – even as concessionary lending has come to an end due to monetary tightening – could indicate that the purported capex has not resulted in a rise in capacity utilization or industrial output, considering that ST credit to the private sector has plateaued in nominal terms over last 12 months.

But as perverse as SBP’s experiment in ‘trickle up finance’ of the last decade – especially (since 2020) – may have been, it may ensure one thing. If (or when) the chips of sovereign default fall, private sector credit – lent out to Pakistani business elite’s chosen few – may remain unscathed.


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