Islamabad-Moody’s Investor Services (Moody’s) stated that economic activity in Pakistan will remain below pre-epidemic levels, but the economy should return to a modest 1.5 percent growth in fiscal year 2021.
“Pakistani banks are facing slow economic recovery, but solid funding and liquidity support the stable outlook” in Moody’s latest report, stating that the coronavirus pandemic has weighed on economic activity in Pakistan and real GDP contracted by 0.4 percent in fiscal year 2020. The economy will return to growth and reach a modest 1.5 percent in fiscal year 2021. While high-frequency indicators show that economic activity is starting to recover, restrictions on actions to curb the spread of the coronavirus will keep economic output below pre-epidemic levels for some time. However, growth will accelerate to 4.4 percent in 2022 ”. Moody’s said, “We expect the Pakistani economy to return to a modest 1.5 percent growth in fiscal year 2021 after a recovery in activity at the start of the fiscal year in July.
As slow economic recovery hurts government finances, successive waves of coronavirus infection will suppress consumer spending and business confidence, all of which will affect the banking sector. Moody’s predicts an 8 percent government deficit for 2021, with increasing debt and cyclical debt in the energy sector also impacting companies’ repayment capabilities.
“We think the risks to the Pakistani economy are lower than that of similar proportions. Pakistan’s relatively closed economy has low dependence on exports and private capital inflows, and limited trade and supply chain links. This reduces the risk of exposure to weak global demand, including international tourism, ”he said. The report also noted that large fiscal deficits, which will be financed largely by local banks, may take precedence over loans to the private sector. Lower consumer spending and business confidence will suppress credit growth and business opportunities. In this environment, Moody’s expects private sector loans to grow between 5 percent and 7 percent, below inflation expectations of 8 percent in 2021. Interest rates continue to remain on the low end of historical rates, but muted confidence levels will hamper stronger growth.
Moody’s also stated that Pakistan remains on the Financial Action Task Force (FATF) gray list due to shortcomings in anti-money laundering (AML) and terrorism financing (CTF) capabilities. Failure to meet AML requirements can force international banks to cut off correspondent bank relationships, affect banks’ foreign currency liquidity, job creation capabilities, and lead to higher refinancing and compliance costs.
However, the authorities agreed on an action plan with the FATF to negotiate an exit from the gray list and are now largely addressing 21 of the 27 actionable items. Due in part to AML issues, Habib Bank and United Bank surrendered their US banking licenses and closed their US branches.
The State Bank of Pakistan (SBP) targeted 65 million active bank accounts, with total deposits accounting for 55 percent of GDP, through the increased use of mobile bank accounts, biometric verification systems and QR codes. Targeted 25 percent market share for Islamic banking by 2023, with an advanced Sharia governance framework and initiatives to streamline liquidity management. Islamic banking assets accounted for 16 percent of banking assets as of September 2020. Increase SME lending to about 17 percent of private sector loans by 2023 by providing a facilitating regulatory framework and increasing ease of doing business.
A new Pakistan Credit Guarantee Company and the Register of Secured Transactions will support banks in achieving this goal, and by December 2021 by increasing housing finance to 5 percent of private sector lending, a government increase subsidy and augmentation initiatives that facilitate banks to achieve this target by 2023. Agriculture finance targeting to pay 8 trillion Rials and 6 million borrowers.
Pakistani banks are heavily exposed to the B3-rated Pakistani ruler through large amounts of government bonds and loans. This links their creditworthiness to that of the government. Pakistani banks hold government bonds worth Rs 10.3 trillion, which equates to 7.2 times their Tier 1 capital at the end of September 2020. Risk rises to approximately 9.0x Tier 1 capital, including loans to government and public sector entities. . As Pakistani banks will continue to be the main source of funding for the government, we expect the government risk to remain high from our point of view. “The government’s commitment to stop borrowing from the central bank will also lead to increased government confidence in banks to meet their financing needs,” he said.
Non-performing loans (NPLs) in the Pakistani banking sector rose to 9.9 percent of total loans as of September 2020 (8 percent as of December 2018) and we expect further growth as the economic slowdown reduces borrowers’ repayment capacity. Moody’s added. Credit repayment holidays and other support measures will include deterioration but will not eliminate risks. Various sectors will bear the burden, including energy (affected by high cyclical debt), agribusiness and sugar, risks to the SME sector, and export-oriented businesses, as well as banks’ external operations (especially in the Gulf). Credit quality risks will be mitigated by improvements in the legal and regulatory framework to support NPL recovery.