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P= Provisional
* WAPDA, OGDC, PTCL, SSGC, SNGPL, KESC & PR

Other salient features of the comparison between what had been targeted and realized are:

The sharp increase in commodity operations on the strength of a bumper wheat crop,

The figures show that autonomous bodies did not borrow as much as anticipated in the Credit Plan for FY00 . However, a sharp seasonal increase in borrowing was nevertheless witnessed during June 2000,

There was a sharp fall in non-government borrowing primarily on account of: (1) the loan recovery drive following the change in government, (2) eligibility restrictions on the export finance scheme (EFS) following a sharp increase in lending in FY99, and (3) lower lending by other financial institutions on account of exceptional indirect lending during FY99 that could not be sustained in FY00, and

As expected, without IFI assistance, liquid reserves fell in FY00 against a targeted increase in the Credit Plan; NFA fell by Rs 4.9 billion against a projected increase of Rs 12 billion projected in the Credit Plan. This fall in NFAs would have been sharper had SBP not actively purchased hard currency from the kerb market.

Monetary and Credit Developments during FY00
Overview
As shown in Figure V.1, although growth in money supply was higher in FY00 than the previous year, private sector credit off-take during the second quarter of FY00 (October to December 1999) was far smaller than the corresponding period last year. Against an increase of Rs 68.4 billion in the period July to December 1998, the corresponding amount in FY00 was only Rs 28.7 billion. In normal circumstances, the sharp seasonal increase in the second quarter of the fiscal year reflects cotton financing. The slow off-take, despite a vibrant cotton season suggests an important role of self-financing.

Stepping back, sluggish private sector credit off-take during FY00 coincided perfectly with the aggressive loan recovery drive launched by the new government. Since the bulk of these delinquent loans are long-term in nature, net credit disbursed to the private sector for fixed investment fell sharply (see Table V.2). Greater details on the loan recovery drive will be addressed in the sub-section on Pakistan’s banking system.

Government sector
Looking at government borrowing, there is a clear reversal during FY00. Against net retirement of Rs 75.2 billion during FY99, the government borrowed Rs 40.0 billion this year. Accounting for the Rupees placed by the government in SBP against external payments that have been rescheduled, gross budgetary borrowing in the years FY99 and FY00 was Rs 18.2

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* Excluding small loans.

billion and Rs 104.2 billion, respectively. As shown in Figure V.1, till end-November, government borrowing from the banking system was actually higher in FY99 than in FY00. It is clear from this that the government was able to find an alternative source of funding in FY99 since the nominal size of the fiscal deficit actually increased in FY00. To analyze domestic sources of government financing in the two years (FY99 and FY00), it is important to take into account the launch of Special US Dollar Bonds on 21st July 1998.

Although this was meant as an incentive to encourage deposit holders to liquidate their frozen FCAs, a more fundamental force was at play. While FCAs are a central bank liability (where the Rupee counterpart/equivalent was provided to mobilizing banks), the Special US Dollar Bonds are a GOP debt.  In effect, for each Dollar converted, GOP increased its external financing of the fiscal deficit by the equivalent Rupees. This explains the sharp increase in external financing following the freeze of FCAs. For example, while external financing averaged only Rs 29.8 billion during the period FY94 to FY98, during FY99 the amount realized was Rs 147.0 billion, while the tentative estimate for FY00 is Rs 73.6 billion.

In overall terms, while FY99 experienced significant financing from external sources (both Special US Dollar Bonds and IFI assistance), FY00 witnessed tapering conversions from FCAs to US Dollar Bonds, while limited assistance from IFIs reduced actual inflows of foreign assistance. While these two factors undermined the magnitude of external financing in the year, the three consecutive cuts in NSS rates (since May 1999) coupled with the ban on institutional investment (effective April 2000), reduced inflows from non-bank sources relative to FY99. In effect, despite the increase in the fiscal deficit in FY00 (in Rupee terms), the reduction in external financing and non-bank borrowing left little option to the government but to borrow more from the banking system.

Despite these changes in the pattern of deficit financing, there was no upward pressure on T-bill rates since the government continued retiring its debt to commercial banks, while by borrowing heavily from SBP. The retirement of government debt to scheduled banks allowed T-bill rates to fall, and since SBP financing is priced at the last primary auction rate, this allowed the government to step-up its net borrowing from the central bank at lower rates. In overall terms, GOP retired Rs 84.1 billion to scheduled banks in FY99, and even more during FY00 (Rs 95.0 billion), while the corresponding increase in net SBP financing jumped from Rs 8.9 billion in FY99 to Rs 135.0 billion during FY00 (see Table V.1).

Another point to note in Figure V.1, is the sharp increase in commodity operations. As discussed in Chapter II, Pakistan was fortunate to realize a bumper wheat crop in FY00, largely driven by the timely 25 percent increase in support prices in November 1999. Since the purchase of wheat constitutes the bulk of the government commodity operations, the Rs 40.1 billion should be a one-off development even if the country is fortunate enough to realize another large crop during FY01. This can be seen in the Credit Plan for FY01, where commodity operations are targeted to have no net impact on money supply growth.

Non-government sector
The non-government sector also experienced special developments during FY00. As stated earlier, the loan recovery drive in late 1999 undermined cotton financing, and other fixed-term lending. For the most part, net disbursements in the latter half of the fiscal year remained stagnant. There were, however, new developments in FY00: looking at credit disbursed to the private sector between end-March and end-June 1999, increased by Rs 13.9 billion, while the corresponding period in FY00 witnessed a net retirement of Rs 14.5 billion (see Figure V.I). Excluding export finance, private sector credit increased by Rs 4.4 billion in the last quarter of FY99, while the corresponding period in FY00 witnessed a contraction of Rs 4.4 billion. The smaller contraction in lending during FY00 can be attributed to the loan recovery drive, the Tax Amnesty Scheme, the launch of the Tax Survey, and the sharp increase in commercial bank financing of commodity operations. Furthermore, uncertainty about the upcoming Budget and whether Pakistan would be able to secure an IMF program must have also had an impact in FY00.

As stated earlier, despite healthy growth in exports (especially in the textile sector), net credit disbursed through Export Finance Scheme (EFS) showed net retirement in FY00 (see Table V.1). The non-eligibility of EFS financing for cotton yarn below 30 count after December 1999, the short-term maturity of these loans, and the fact that low value-added items were only made eligible for EFS financing on 10^th March 1999 (which resulted in a sharp increase in FY99), explains the reduction shown in FY00.

In terms of autonomous state-owned enterprises, FY00 closed lower than FY99 in terms of net borrowing by seven specific utilities and gas companies. However, since the FY00 target of Rs 8.5 billion included an expected inflow of IFIs assistance of Rs 5.5 billion for the restructuring of WAPDA (which was not realized), the actual target was only Rs 3.0 billion. Hence, the Rs 3.1 billion that was availed is not reflective of exceptional circumstances. During the course of FY00, PTCL continued to retire its bank borrowing, which pulled down the overall balance till the seasonal hike in June. In FY99, the bulk of borrowing was by KESC, which availed Rs 11.4 billion as part of its internal restructuring; this was not repeated in FY00. This made up the bulk of total lending to autonomous bodies during FY99 (Rs 13.0 billion). More broadly, the tendency of autonomous bodies to retire bank credit throughout the year (with the exception of June) is reflective of efforts to wean these institutions off bank credit to finance their operations.

Looking at net lending by specialized banks, there is a sharp reduction in FY00. Against net lending of Rs 14.9 billion during FY99, FY00 only posted an increase of Rs 2.9 billion largely because of the sharp curtailment by ADBP. Although the premature end of the subsidized scheme to finance tractors played an important role in this curtailment, SBP also made it clear that ADBP would not be provided with SBP financing to meet its lending operations. In effect, ADBP had to improve its recovery of past loans to finance fresh lending. Hence, this fall in net lending should not be viewed negatively, since specialized banks need to operate on commercial basis to ensure sustainability of their directed credit mandate.

Disbursements by other financial institutions show a very sharp reduction in FY00 compared to the year before. This is not surprising since the Rs 18.9 billion disbursed during FY99 was funded by the Rupees generated from foreign exchange swaps by certain investment banks operating in Pakistan. As a norm however, these institutions play a very marginal role in lending to the private sector, as the disbursements in FY98 (retirement of Rs 700 million) and FY00 (retirement of Rs 29 million) show.

This discussion suggests that if non-government borrowing is to be used as a barometer of private sector confidence during the year, lending through EFS and net disbursements by specialized banks and other financial institutions should be excluded.   In terms of specialized banks, efforts to improve their lending performance explains the curtailment, while the liquidity boost in other financial institutions explains the exceptional increase in net lending during FY99. These developments show that the fall in lending has largely taken place because of special circumstances in both years, and should not therefore be used to show worsening recessionary conditions.

The unspecified or ad hoc impact on money supply "other items (net)" shows an expansionary impact of Rs 20.6 billion during FY00. This special development took place in the month of June 2000, where a large part of the Rs 25.9 billion increase (in just that month) was on account of larger SBP profits surrendered to the government. With substantial government borrowing from the central bank and lower depreciation of the Rupee during FY00, SBP profits were significantly higher in FY00.

Looking at credit growth, domestic credit expansion during FY00 is almost three times what it was in FY99. Clearly the swing factor was the government sector, which moved from retiring Rs 74.5 billion in FY99 to borrowing Rs 78.0 billion in FY00. This creation of domestic liquidity was partially neutralized by net foreign assets (NFA) of the banking system. While Pakistan experienced a substantial increase in its foreign reserves during FY99 on the basis of IFI assistance, FY00 witnessed a contraction in domestic liquidity as reserves ended at a lower level in June 2000 relative to where it had started the year.

The developments discussed above managed to contain M2 growth to Rs 120.1 billion in FY00. As shown in Figure V.1, the bulk of this increase in money supply was concentrated in the last quarter of the fiscal year. The onset of wheat financing and the seasonal increase in credit disbursed to autonomous bodies is primarily responsible for this increase in money supply.

In overall terms, the growth of money supply has been subdued in the past two years, which implies that there are no inflationary pressures from a monetary overhang. However, the sharp increase in reserve money during FY00 (specifically, currency in circulation) is a cause for concern. A related development is the changing composition of Pakistan’s money supply. However, before addressing this issue, a discussion of private sector credit is in order.

Sectoral distribution of private sector credit
As shown in Table V.2, net disbursements of small loans have fallen during FY00. The sharpest fall is in agriculture, where the recovery drive was more effective, while the improved cotton and wheat crops provided liquidity to set-off outstanding loans. Facilitating this development was efforts to wean ADBP off central bank financing and credit lines from commercial banks. Furthermore, repayments against the increase in agricultural credit in FY99, have dampened net disbursement this year. There is also a view that the enforced credit discipline from the recovery drive may have forced some farmers to substitute towards informal finance.

Loans for businesses (primarily small and large retail/wholesale trade) posted a fall in FY00. Higher utility prices and a slowdown in commercial activity in view of the prevailing accountability drive, contributed to this lackluster off-take of credit. The strikes against the documentation drive in the latter half of FY00 also played a role in the slowdown and uncertainty.

In terms of medium and large-scale manufacturing units, interest in LMM financing continued to remain slack. Looking at fixed investment loans, although initial doubts following the change in government must have had an impact, the overall accountability drive and suspension of structural adjustment programs with the IFIs, has had a more telling impact. Two issues should be noted

Non-performing loans and defaulted loans largely comprise fixed investment loans. The cash recovered from such assets is reflected in lower net disbursements for fixed investment.

Gross term lending by commercial banks has been hit on both the supply and demand side. On the demand side, the sense of uncertainty with the accountability drive coupled with the absence of IFI programs must have clouded the medium-term investment horizon. With the end of the consolidation period in December 2000, investors are still seeking some assurance that Pakistan would be able to secure an extension knowing this would only be possible with the IMF on board. On the supply side, fears that bankers would also be investigated as part of the accountability drive created a certain degree of hesitancy about financing fixed investments.

In terms of working capital loans, the story is more optimistic. Net disbursements increased sharply in FY00, largely on account of resurgence in textiles. Other sectors that borrowed more during FY00 were edible oil, beverages, leather and chemicals (as complementary inputs in textiles). The remaining sectors showed the following trends

The automobile sector posted a fall because of high borrowing in FY99, and the fact that production growth fell from an impressive 18.6 percent to negative 1.2 percent in FY00.

Working capital loans availed by the cement sector showed an increase despite negative growth in production (see Chapter II). As the main input in the cement sector, the sharp increase in the domestic price of furnace oil, from Rs 6,070 per MT at end-June 1999, to Rs 9,680 at end-June 2000, more than justifies the higher borrowing in FY00.

The fertilizer sector reduced its net borrowing primarily on account of substantial borrowing during FY99.

Sugar recorded the expected downturn. With production falling by about 31.4 percent during FY00, working capital needs eased significantly. Coupled with past repayments, the sugar sector posted a net retirement of Rs 2.6 billion.

Although textiles showed very sharp growth, the reasons for the growth in working capital loans are not obvious. Although it is simple enough to point to the impressive increase in production, one must keep in mind that domestic prices were low (which reduces their credit needs), while BMR activity that picked up in the last quarter of FY00, is not financed using working capital. Anecdotal evidence suggests that substantial profits earned by the textile sector coupled with the hesitancy of banks, resulted in a degree of self-financing of fixed investment.

Composition of Money Supply
The two years FY99 and FY00 have been extraordinary for Pakistan’s banking system. FY99 captured the impact of the freeze of FCAs, the resulting conversions out of these accounts, and the introduction of the new FE 25 scheme (see Figure V.2a). FY00, on the other hand, was unable to show the expected consolidation in the banking system, as circumstances were such that depositors were hesitant about maintaining their funds in banks. Although FY99 was impressive in that banks were able to contain the panic and even managed to increase their deposit base, this pace could not be maintained during FY00. The year started with unsuccessful discussions with the IMF and a subsequent suspension of their programs with Pakistan. With the change in government in October and the steps taken to enforce accountability and implement a comprehensive documentation drive, commercial banks faced an uphill task retaining their Rupee deposit base.

Looking at Figure V.2b, a few salient points should be highlighted:

As mentioned earlier, the increase in money supply was larger in FY00 relative to the year before.

In terms of composition, while the bulk of the increase in FY99 was on account of demand deposits, almost 56.6 percent of the increase in money supply during FY00 was because of a sharp increase in currency in circulation.

The rationale for developments in FY99 is simple enough: depositors either shifted their frozen FCAs to NSS instruments, the lottery schemes launched by NCBs, or moved into hard currency via the kerb market. In any systemic movement of this nature, the Rupees used to purchase these assets are reintroduced into the economy and return to the banking system. However, these new depositors are generally not savers and therefore prefer to place the money in short-term instruments (demand deposits).

In the case of currency in circulation, the sharp increase witnessed during FY00 cannot be explained by demand to back up commercial transactions (transaction demand). Given the subdued growth of currency in circulation during FY99, it is clear that other factors were at play. With the change in government in FY00, and the overriding accountability drive, individuals seem to have sought the comfort of cash. There are three factors that could support this view: (1) since inflation is the cost of holding Rupees, the fall in FY00 reduced the opportunity cost of hoarding cash (2) as cash is the most convenient and untraceable avenue to hide wealth, the accountability drive launched in the latter half of FY00, created a clear incentive to hide personal wealth and (3) the likely increase in self finance for working capital or fixed investments could explain an exceptional increase in cash balances. The suggestion that specific neighboring countries are using Rupees locally, could not explain the sharp increase witnessed in FY00.

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1 Excluding interbank deposits, deposits of Federal and Provincial Governments and foreign constituents.
2 Excluding IMF A/C Nos. 1 & 2. SAF Loan A/C, counterpart funds, deposits of foreign central banks, foreign governments, international organizations and DMBs.
Note: Figures in parentheses show percentage shares in total monetary assets (M2).

For a proper assessment of the liquidity problems facing banks, two interrelated issues need to be discussed:

In April 2000, there was a change in the categorization of resident-FCAs (RFCAs). As shown in Table V.4, there was a sharp fall in demand deposits and a corresponding increase in RFCAs. This shift represents the inclusion of resident FE 25 deposits, which were, since their launch in July 1998, included as part of demand deposits. Since April 2000, these deposits have been correctly categorized as RFCAs.

More importantly, unlike the frozen FCAs, FE 25 deposits do not provide Rupee liquidity to mobilizing banks. This implies that mobilizing banks cannot swap the hard currency for Rupees (with SBP) to finance their lending operation. In effect, although resident-FE 25 deposits are part of the aggregate deposit base, these deposits cannot be used for Rupee financing. Moreover, since banks also have to meet CRR and SLR requirements on these deposits, FE 25 actually reduce the Rupee liquidity in commercial banks. Excluding the Rupee equivalent of resident FE 25 deposits from both demand deposits (between July 1998 and March 2000) and RFCAs (since April 2000), gives a more accurate picture of the availability of Rupees with commercial banks. The abridged Table V.4 is insightful as it shows just the Rupee deposits (demand and time) and the remaining frozen RFCAs that still provide Rupee comfort.

Looking at Table V.4, it is clear that the growth momentum of Rupee deposits (including RFCAs) was robust till the freeze of FCAs, after which growth fell to 3.4 and 3.5 percent for the years FY99 and FY00, respectively. Despite the sharp fall in inflation rates in these two years, in real terms, the lending pool in Pakistan has fallen.

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