BR Research recently sat down with the ex State Bank of Pakistan Governor, Syed Salim Raza to discuss issues surrounding Pakistan's macroeconomic landscape. Below are the edited excerpts from the conversation.
Business Recorder Research: How has the experience been so far at the Pakistan Business Council?
Salim Raza: We have filled the space that we needed to, which is to have an industry body that represents macro issues faced by industry, and to help government develop policy on issues like trade, protectionism and FTAs. We deal with issues that affect manufacturing for industries as a whole, as opposed to representing single industry issues. PBC is poised for sustained success, with a Chairman who has huge experience of the business issues of Pakistan, an MD who has run one of Pakistan's biggest Multinationals and takes deep interest in the subject of industrial development; the government now does consult PBC on subjects of mutual interest and I hope regards PBC as a partner.
In policy development terms, on particular issues, they will ask PBC to develop research and prepare a position paper. For regional trade, and trade with India, PBC is the co-ordinating channel with the Indian private sector or the lobbies of the Indian private sector. That is an example of the PBC coming of age.
BRR: Has the receptiveness increased over the years from the government side?
SR: Often there's good, conceptual exchange that is followed up with concrete proposals, but governments change and other priorities come up. I think lack of continuity is a big problem in Pakistan. If development has suffered, it's because of the lack of continuity; people change, policies change, governments change.
If proposals are crystallised between governments and say the PBC, or other advisory bodies, what has been agreed can be relegated to the sidelines if other priorities emerge? So the problem isn't the lack of receptiveness, it's the lack of continuity. The last government had, what, four finance ministers, four governors of State Bank, and as many Chairman FBR, in five years. And whatever you are doing is anchored in one part or the other of the government. If people change, you lose momentum. This is a continuing problem with policy development.
In India, given the existence of particular Institutions, lot of heavy planning can proceed long-term with the help of private sector, given its size and depth of its capital resources. For example, there are a variety of public private participation programs, infrastructure development banks and the Indian States have their own infrastructure finance programs.
And many of these long term PPP programs are financed by private sector with the government's exposure restricted to the liability gap - the difference between commercial return and return that the government controls. This difference crystallises as the cost to the government, not the cost of the whole project. Because of this, a lot of development is carried on and driven by institutions like these banks and by the depth of capital resources within India, and of course, India's commercial access to FDI and international markets.
Therefore in India, investment sustainability is reasonably well assured. Just look at the numbers - our investment is down to 13 percent of GDP compared to 33 percent in India and 29 percent in Bangladesh. So, when I say continuity, it's not just government it's also the institutions that oversee development like the infrastructure finance banks, the PPP programs. Indian states collect a lot of taxes - 40 percent of national taxes; our provinces collect five percent. So that is another capacity that Indian states have to continue their work irrespective of change at the top.
State governments are internally competitive there when it comes to development. Gujrat's success is excellent infrastructure; one window approvals. Modi's success was actually based on Gujrat running far ahead of other States. So, the institutional umbrella; depth of financial resources in the private sector, Sates' involvement in development, capacity within the states to carry on large scale work by themselves, gives development a sustainable underpinning.
We haven't developed that due to many reasons like the law and order problem in parts of the country, and because of an uncertain record of contract enforcement. As a repercussion, a lot of mining resources are underdeveloped in Pakistan and mining is a provincial subject.
We have to think about where our future development should be; we keep thinking about manufacturing but we are a bit stuck in the mud when it comes to manufacturing. Let's think of metals, mining, energy resources, national trade corridor, trade cooperation where Pakistan becomes a link in the chain - it is not just transport or logistics that Pakistan can be used for, we can be part of the value chain. China is moving a lot of its garments industry to the south, to Vietnam, Myanmar and Bangladesh. Similar thing could be done here.
BRR: Do you see this shift happening from manufacturing to the sectors you mentioned?
SR: Mining is relatively long gestation. You need to be confident about matters like sanctity of contract, enforcement, and Property rights. Law and order is a deterrent, yes, but that "cost' goes into the accounting and cost of the project. What they want most is continuity of policy and that is where our institutions have to demonstrate more independence.
We need to reorganise our relationship of ministries with formal institutions, so that the institutions can retain their independence, which is necessary for a synergistic partnership. The institutions need to be supported by independent BoDs. And whether we choose to privatize something, or put it into some version of PPP, or keep it entirely under Government control, should be a decision reached freely between the BoD and the respective Ministries.
If areas such as mining are recognised as priority, we have to build the institutions that can develop the right policy and that process will bring not just foreign investment but also domestic investment. The problem is: where are our big domestic investors with respect to this segment.
In general, if the big groups do not invest locally, it is a deterrent to foreign investors, because foreign investors follow the confidence and appetite of local ones. Pakistan has a huge consumer population and one of the largest youth populations in the world. The foreigner invests either for export or to sell domestically and we have both possibilities.
Growth in Japan and Korea was led by domestic companies under a huge wall of protection until those companies were prepared to compete abroad. They made their brands within. Then, they slowly broke down the trade barriers because they were ready to compete. China went the other way.
It opened up to foreign investment and foreign competition and the local manufacturers had to compete. They took the more challenging path and look where they are now; they make more cars than Japan and Germany combined if I am not wrong. They let foreign investment in, to galvanise their own capacity and have had even more success than Japan and Korea in mobilising rapid growth in a short period of time.
BRR: We are neither here nor there; which path are we taking?
SR: Well, again this comes to continuity of policy. If it's going to be Thar coal, let's do it; if it's a hydel dam, let's do it; if it's going to be logistics, let's build these special economic zones and roads and rails. We need to crystallise it to the core fundamentals that are going to accelerate growth - and they have to be based on our resources. China's resource was its people - low cost labour. China is the biggest importer of energy in the world, they invest everywhere for coal, gas, metals, minerals and food. But they have got this vast export engine that can pay for everything they are importing.
We have never really got out of the import substitution mentality, but you have to see a time when you won't have to import machinery. Firstly, you should be able to export something to pay for the imported machinery, and secondly you have to start building the capacity to delete what you are importing. Take textile industry - we have been going 70 years; we should be making textile machinery. Japanese and Koreans gave limited protection - for a certain number of years - at the end of which the barriers would have been lifted. So the companies were forced to build up supply chains and eventually they were producing the heavy industrial requirements.
BRR: What is your view on the banking sector?
SR: Banks are holding two-thirds of their assets in government securities and direct credit to Government/PSEs. This is where we were in the late-90s. One of the bonuses of privatisation of the banking sector was that this two-third, one-third ratio would invert. In 1999-2001, the sector was really privatised, we saw new banks coming in and by 2007, the ratio had inverted - 70 percent private and 30 percent government securities/credit, which is how it should have been. Now we are back to where we started from. So the banks are privatised but their assets are 'nationalised'.
I think the government could have done a lot to develop distribution channels for debt outside banks eg mutual funds. If the private sector would not, then it is the government which should have deepened the mutual funds industry. The government should have a professional debt management function which assesses short and long term requirements, look at different distribution channels and promote Pakistani debt abroad.
Had a professional debt management function and wider distribution channels developed, banks would have been forced to develop other domestic capital markets for debt, like commercial paper, banker acceptance and corporate bonds market - besides lending more to the SME and Agricultural sectors.
BRR: Is risk now a bigger factor for banks than the yields they are making; it seems they are happy making lower yields than taking private sector risk and there is a genuine lack of demand.
SR: There is some genuine lack of demand, matching our low GDP growth rates. There has been credit compression (ie growing historically below inflation). Lending is largely pushed to the top 100-150 entities of Pakistan; but the agriculture, consumer and SME sectors have seen a relative contraction - SME lending has come down from 17 to about six percent of total bank exposure.
SMEs account for 80-85 percent of our employment and 30 percent of our exports. To tackle this issue, we should classify SMEs in clusters and regions and get to understand them well. We should respect the fact that these companies carry on one way or another in less than ideal working conditions, and with restricted access to credit, they mobilise personal equity in one shape or form.
The banks don't see that equity on the books so they think they are highly leveraged. But if the banks understand the business, they know that there is more equity than the books show and more equity ready; there is family and friends, there are resources in his house or some land he (SME owner) may own and that he is willing to leverage all that to keep his business going. That commitment is what lenders or partners want to see. You need to find ways of assessing his true net worth and true cash flows. And then you can lead with a small window of venture capital as well, besides simple secured credit.
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