Covid-19 lessons: Leverage is good?

Fortunately, (or not), Pakistani businesses are not highly leveraged (credit to GDP is half of India, and one third of Bangladesh), and less reliant on exports (goods exports to GDP amongst ten lowest countries in the world). That is why the economic impact would be less severe than other economies. Consumers are not at all leveraged (outstanding house loans are 70,000-80,000 out of 32 million household). Majority of SME businesses are not bankable in Pakistan – out of estimated 4-5 million SMEs, access to finance is available to 100K-150k. Majority of corporate have access to formal financing; but not many are leveraged.

There is a limit to what regulatory easing by central bank (to jack up banking liquidity), and ease in policy rate can lessen the business worries. Nonetheless, such steps are warranted in days of pandemic. Economic slowdown is expected to remain sticky for a quarter or more. Some businesses are affected more and others are less. The problems vary across sectors and firms’ dynamics are different within each sector. There should not be blanket support, and SBP is not offering any.

Last week SBP and Pakistan Banking Council (PBA) deliberated on the relief package and SBP issued a presser on it. Before this issuance, SBP lowered the policy rate by 225 bps to 11 percent. The package is mainly to relax the stringent requirements to create some liquidity. For example, the capital conservation buffer is reduced from 2.5 percent to 1.5 percent. This will allow banks to extend Rs800 billion additional loans.

This is roughly 10 percent of banks commutative loan books. This can be utilized by companies to finance working capital to cover fixed costs. The capital expenditure is not a problem. In days of lockdown, variable cost is zero. The issue is to finance payrolls and other fixed costs. The companies already have cash lines that they can use easily. Those who are bankable (but not currently in borrowing business) can use these. But what about the issues of non-bankable – how will they finance payroll or to meet other needs. These have credit from suppliers, family and friends, and loan sharks. Who will provide them with the needed liquidity?

SBP has increased the limits of SMEs from Rs125 million to Rs180 million permanently. It’s good for a tiny fraction of SMEs which are bankable. What about the rest? Perhaps, it’s a lesson to learn that being bankable is in their advantage. Similarly, the debt burden of consumers is increased from 50 percent to 60 percent. With 4 percent banking assets are of consumers and having virtually no mortgage depth, this will be of little use. Majority of (lower) middle class have credit from informal sector for bike, electronics and other financing needs. How to ease these?

The lesson to learn is being bankable is good. For those who are, they have some cushions. Especially, for leveraged firms. Principal payment of for borrowers can now be extended for one year. This is a good step and its better than mere lowering rates. Any company that wants to extend the mark up, then the loan must be restructured or rescheduled.

Apart from these, some other easing is to done for companies to acquire additional loans or defer repayments. These are good steps and will ease the problem of big firms, and bankable SMEs. For large pool of informal economy in manufacturing and services, one may hope that informal lending institutions (or mechanism) may adopt similar processes. Probably, they have to while the economy is at a pause.