Economic policy is a complex topic. There are intended and unforeseen repercussions, aspects that one can and cannot control. An overreaching judiciary that meddles in commercial transactions as it sees fit without knowing the underlying principles is one example of this.
Banks that were required to pay excess tax due to their failure to meet the tax authority’s advance-deposit ratio (ADR) were recently granted a stay by the Islamabad High Court. Because an overreaching judiciary still dwarfs the ability to implement, such an action essentially mutes the significance of any policy choice.
Over 70% of the assets of the banking system are essentially invested in government securities or loans to public sector or government organizations. This results in a situation known as crowding-out, in which the government restricts the private sector’s access to loans, hence limiting economic growth.
Why would a bank give the private sector the same credit if it can use its available cash for relatively low-risk government lending? Since little capital is moving around to increase overall domestic investment in the nation, credit to the private sector slows down along with overall economic growth, leading to limited economic growth.
Banks’ motivation to lend to anyone other than the government is unintentionally diminished by inefficient policy instruments and judicial interference intended to promote lending to the private sector.
Banks were subject to a tax that required them to pay additional tax if they failed to meet a specific ADR threshold. This was a policy tool designed to encourage banks to shift their investments from sovereign securities to the private sector.
Unintended repercussions resulted from this, such as banks ceasing to accept consumer deposits and beginning to lose deposits. Additionally, they only want to lend to the government, which leaves important sectors like agriculture and small and medium-sized businesses severely lacking in credit and cash.
A banking industry that primarily serves as a conduit for sovereign borrowing is unable to make a constructive contribution to economic expansion. The judiciary is holding back fiscal tools that can encourage the same, which lessens the effect of policies. They might even get involved in monetary policy or other issues if such a precedent is established. A policy arm’s legitimacy is based on its ability to carry out; if stay orders limit that ability, the impact of any policy will be limited.
Increased investment is necessary for Pakistan’s economy to grow sustainably, and this can only be achieved if the system is more efficient. Encouragement of financial institutions to actively participate in the mobilization of capital across an economy is a good economic strategy.
Businesses will still find it challenging to invest, generate employment, and raise the overall supply without capital, which will force the nation to import goods in order to keep up with rising aggregate demand.
Consumption, which is mostly driven by imports, has continuously accounted for more than 92% of GDP over the last five years, while investment as a percentage of GDP has stayed at about 12%. The region’s and our economic peers’ investment-to-GDP ratios remain around 30 percent, which amply illustrates the notable lag.
Financial institutions must actively participate in order to raise this ratio, and effective policy measures are also necessary. Banks in Pakistan must begin lending. Banks continue to be the main source of financing for the economy when there are no robust equity or debt capital markets.
Lending to state-owned companies and other highly regulated industries, like electricity, commodities financing, and government-guaranteed loans, are included in the 37 percent ADR for the whole banking industry. For an economy to grow at a rate that covers population expansion and raises income levels for all, such low levels of capital accumulation are insufficient.
Fiscal policy tools (like the ADR tax, without judicial overreach) and State Bank policy tools (like requiring any bank lending less than 50% of its deposits to place the shortfall interest-free with the State Bank) must be used in tandem to achieve an ADR of 75% by 2029. By that time, the same floor can be gradually raised by 75%.
Policymakers must also recognize that banks’ hesitancy to lend to the private sector is largely due to lax implementation of collateral laws. The infamous “stay orders,” which poor faith borrowers strangely find incredibly simple to get, should not represent a threat to the ease of foreclosing on any type of collateral.
To achieve sustained growth, the ADR tax must be extended, raised gradually to 75% till 2029, and the government must be economically responsible and not run endless deficits. If this doesn’t happen, banks will still serve as conduits for sovereign borrowing, and we’ll remain stuck in the low-growth trap.
