Writing in Dawn on January 3, 2012, Dr. Shahid Kardar, former governor of the State Bank of Pakistan, painted a gloomy, yet realistic, picture of the country’s macroeconomic imbalances. It seems clear that the crowding out of private sector investment due to excessive government borrowing from commercial banks that he describes is closely linked with structural problems within the private sector. These problems, in addition to a smaller window for bank lending to the private sector, include weak corporate governance in many family-owned enterprises, and a lack of equity investment through stock exchanges. Unless structural reforms are introduced in the private sector, which will require action by regulators and businesses themselves, macroeconomic stabilization alone will not bring Pakistan out of its low growth equilibrium.
Dr. Kardar’s arguments regarding the crowding out of private sector lending due to government borrowing at risk-free rates are indeed well-founded. Overall trends in bank credit to the private sector in Pakistan are declining, not only when measured over time, but also in comparison with other regional economies. Within South Asian Association for Regional Cooperation, Pakistan ranks last out of seven members in terms of domestic and commercial credit for the private sector.
According to a December 27, 2011, presentation made by a representative of the Federation of Pakistani Chambers of Commerce and Industry at a conference in Islamabad on “Economic Connectivity and Regional Trade,” domestic credit to the private sector in Pakistan represents 21 percent of GDP. This is better than Afghanistan – where domestic credit barely rises above 10 percent of GDP – but in India, this figure is 50 percent, in Sri Lanka, it is 28 percent, and in the Maldives, it is 65 percent.
The State Bank notes that government borrowing from commercial banks increased by Rs 590.2 billion ($6.4 billion US) in FY 2011, compared with an increase in private sector credit of Rs 121.3 billion ($1.33 billion US). The State Bank clearly states that “there is little doubt that government borrowing is distorting credit conditions for the private sector.”
Given populist tendencies in both the central and provincial governments, it seems unlikely that the government will get out of the way and let the private sector partake of commercial credit. In this light, it is fitting to ask what alternatives we have to facilitate private sector growth, to allow the private sector to lead the country on a path of economic recovery. One answer is an agenda for private sector restructuring, presented below in an effort to generate further discussion.
It is evident that Pakistan’s largest firms, even those listed on stock exchanges, are essentially family-owned enterprises. According to sources in the Karachi Stock Exchange, family-owned enterprises comprise as much as half of the 660 listed companies. These enterprises typically resist expansion through the dilution of shares, even at the cost of growth. While control over assets is a basic economic right of these families, engaging professional management, with a reasonable stock options structure for these executives, can help such enterprises to expand.
There is a clear need to work with Pakistan’s family-owned enterprises to encourage adoption of the Code of Corporate Governance and equity-dilution models. In this context, the Pakistan Institute of Corporate Governance is doing important work along with the Securities and Exchange Commission of Pakistan (SECP). While changing attitudes is not easy, adopting appropriate frameworks and systems can facilitate the process.
Next, these families also need assurance that the threat of nationalization, still fresh for the oldest generation, is no longer a reality, and that they will themselves be the greatest beneficiary of expansion. Another important incentive for family-owned enterprises, both listed and unlisted, to follow the Code of Corporate Governance, will be greater access to funds, as lenders and investors alike feel more comfortable working with firms that adhere to the highest standards of corporate governance.
Further, it will be necessary to work with stock exchange stakeholders, including investors, and front-end and back-end regulators, to encourage long-term equity investment in the shares of listed companies, rather than day-trading, as well as to facilitate a favorable climate for new IPOs. Stock exchanges should be a place for raising new funds for expanding enterprises. Unfortunately, the number of IPOs launched in the last five years in Pakistan can be counted on one hand.
In conclusion, Pakistan faces an immediate need for private sector restructuring, comprising reforms in corporate governance of family-owned enterprises, and greater regulatory oversight of stock exchanges. This may involve national-level consultation and coordination among the State Bank, SECP and stock exchange regulators. While there is no easy way out of the current economic crisis, shifting the argument away from the country’s much criticized macroeconomic management, and instead to need for private sector restructuring, could help steer decision-makers in an important direction.