Investment Scope in Pakistan

The Capital Markets in Pakistan have not yet played a significant role in mobilizing savings and allocating it for long term projects, infrastructure and housing. The scope for an expanded menu of products and instruments is quite vast and still the potential has not been tapped. Short term trading and capital gains have been detracting the nation from the fundamental objective which capital market should strive to serve.

It is assumed that Pakistan is consumption led and fuelled by bank credit. But if a realistic approach is adopted, one can confirm this trend, by indicators like imports of machinery and equipment, exports of engineering goods, sale of cement and steel etc. The question that arises is: Is it the public sector or the private sector that is contributing to investment in the country. The answer to the said question is that about three-fourth of total investment have been made by the private sector while public sector corporations and General Government provided the rest one-fourth. Thus it is clear that most of the investment is led by the private sector.

The information available on the breakdown of private sector’s investment and the growth recorded for each sector show that manufacturing, transport and communications and housing together account for 70 % of fixed capital formation by the private sector. The fastest growing sector of any substantive nature is Transport and Communications. Whereas other sectors attracting private investments are Agriculture, Mining, Manufacturing, Construction, Electricity & Gas, Trade, Finance & Insurance, Ownership of Dwellings and Services.

Private Sector Credit by banking system in FY05 is reported to have been about Rs.400 billion. After excluding consumer loans and other types of loans the private business enterprises received approximately Rs.300 billion from the banks i.e 75% of total bank credit for private sector. Two million borrowers of consumers finance, personal loans, credit cards, auto loans etc. received Rs.100 billion or an average amount of Rs.50000/- from the banks. Experts think that in an economy of over Rs.7.5 trillion, it is this insignificant amount of Rs.100 billion of consumer finance that is actually responsible for all the growth. Investment of Rs.1 trillion, on the other hand, does not do anything and sits idle.

Discussing the private sector credit provided by the banking system in FY 05, we see that large scale manufacturing got the highest share of Rs.163 billion or 54 %, SMEs Rs.82 billion or 27% and the remaining sectors of the economy claimed about Rs.45 billion. The working capital requirements borrowed by the private businesses from the banks were estimated at Rs.160 billion while Rs.20 to 40 billion went for trade financing. Thus Rs.100 to 120 billion of bank credit was used for fixed investment by large, medium and small enterprises in agriculture, manufacturing and services sectors. This implies that the banking system caters to 10 to 12 percent of fixed investment requirements of the private sector. Initial public offerings by the non-financial private corporate sector through stock markets and the term finance certificates issued in FY 06 were able to mobilize around Rs.20 billions.

Non banking financial institutions were estimated to supply 2 to 3 percent more fixed investment. Mutual funds with assets of over Rs.120 billion were mainly involved in badla market for equity trading and it is not obvious as to how much allocation they made for the purpose of investment. Insurance sector can furnish another 1 to 2 percent of fixed investment. Foreign direct investment would have contributed another 1 to 1.5 percent of private sector investment after excluding privatization proceeds.

Discussing all these hard numbers and soft estimates the organized financial sector provides at best only 20% of the financing for private fixed capital formation undertaken in the country. Around 80% of fixed investment is raised by the private sector investors through internal generation of funds i.e reinvestment of corporate earnings, self financing, informal sector or family and friends.

Such a large dependence on internal sources and self financing is major limiting factor that is keeping private sector investment so low relative to other countries in the region. Most of the debate in the country on low investment ratios has been centered on factors such as infrastructure, Law and Order, skill shortages and bureaucratic hassles. Every one of these factors is quite valid and efforts should be made to overcome these constraints. But after all Pakistani businessmen and entrepreneurs from all walks of life invest about Rs.800 billion of their own resources and funds every year. Indeed this high equity debt ratio of 80:20 is too burdensome.

Over viewing the demand side, the credit starved sectors of the economy are crop production, livestock, fisheries, food processing, agro-based industries, small and medium manufacturing, transportation marketing of dairy, poultry, meat, fruits and vegetable and housing for own occupation. Investment in most of these activities is highly inadequate in relation to the rising incomes and demand for these products and services in the country. Self financing and informal sources are highly volatile, erratic and uncertain or expensive and therefore they limit the volume of funds available for investment in these activities. The inadequacy of this investment has serious repercussions.

The consumers in the urban areas and towns suffer as supply shortages push up prices of these commodities. Non-agriculture activities which supplement farm incomes in rural areas cannot be expanded and thus fail to provide the cushion for rural poor. So from an economic viewpoint, investment ratio is sub-optimal, supply shortages persist, urban Consumers face inflationary pressures and the rural poor remain vulnerable to vagaries in prices and output of major crops. As the Government has to import these commodities to meet domestic demand and contain inflation so the trade balance remains under pressure.

To resolve these issues the authorities should adopt some strategies. Mortgage financing which just took off in the country only a few years ago has been stifled. The artificial and speculative rise in the prices of Urban land has made house building out of reach for a large segment of middle class. At the same time the instruments developed by the banks to supply funds are still plain vanilla type and are not of much interest to the borrowers. Fixed interest rate mortgage has not yet become popular with our bankers while other sophisticated products are not yet available. Financial engineering can help in adequate risk sharing arrangements between the borrowers and banks and lead to a resurgence in mortgage financing for the middle income class of the country.

The public sector borrowing requirements from the banking sector including the SBP have to be reduced. As infrastructure and human resource development are long development projects they should be financed though domestic bonds of 10-20 years maturity such as Pakistan Investment bonds, external borrowing on soft terms from the World Bank, ADB and IDB, external bonds of longer duration in international capital markets, non-banking instruments such as National Savings Schemes and Postal Savings Schemes, floatation of shares of public corporations in equities market, GDRs and ADRs. This kind of a reallocation will free up the assets of the banking system to be utilized for private sector investment in the underserved sectors and credit starved activities of the economy described above. As most of these activities are labour intensive, the flip side of this diversion from public sector credit to private sector will increase in employment and rural incomes in the short to medium term.

The value chain of the financial sector ranging from capital markets at one end and micro-credit at the other, with the banking sector followed by non-banking finance companies in the middle should have a better and more clearly delineated division of responsibilities. Large and well established corporate, multinationals, capital intensive private infrastructure projects should access domestic equities market and corporate bond markets for their fixed investment requirements. Some of the large firms needing foreign exchange or having export oriented industries should take advantage of bench marks established by sovereign borrowing in Eurobond, Islamic Sukuk and US dollar bond markets by floating their own corporate paper in international capital markets. This diversion of demand of the borrowers for funds will make additional liquidity available to the banks to concentrate on mid market borrowers. The banking sector will have to, per force, move away from cozy and lazy relationship banking to struggle in areas such as agriculture production and marketing, dairy, live stock, fisheries, SMEs, urban and intercity transport, storage and processing facilities, super markets, housing, commercial office buildings, municipal finances etc. Technology and human resources acquired by the banks in recent years should help them in tiding over this shift.

                       

The space for institutional investors has to be expanded by encouraging, facilitating and attracting private equity funds, private pension funds, provident and gratuity funds, Real Estate Investment Trusts, endowments, insurance companies, mutual funds, asset management companies to mobilize savings from retail savers and provide those funds for long term investment financing. Competition and attractive rates of return will help both the savers and investors. These institutions will also act as a potent force for improved standards of corporate governance, better disclosure and transparency. The rules for mergers, acquisitions and takeovers, corporate restructuring, should be altered to extract value from inefficient, imprudent and dishonest firms. Thus we will be able to have the beginning of a responsible, well performing and globally competitive corporate sector. The matching of long term assets and liabilities through these institutions will mitigate the risk of maturity mismatch in the system.