News Analysis: Protecting their TERF

There has been a lot of noise regarding the Temporary Economic Refinance Facility (TERF) which was initiated by the State Bank of Pakistan (SBP) in the first quarter of 2021 to provide an impetus to the economy during peak pandemic days. During that time, the economies across the world were fluctuating between extended shutdowns resulting in severe economic losses across the board, as well as loss of jobs.

The SBP announced the scheme to provide support to businesses during such a time of uncertainty, thereby incentivizing investment in long-term projects, which would stimulate the economy, and create more jobs. Any design of scheme during such a stressed period can never be perfect, given paucity of data and time.

The scheme envisaged a concessional mark-up rate, which was capped at a maximum of 5.0 per cent per annum, wherein the SBP promised to refinance the same at 1.0 per cent per annum. Effectively, a commercial bank can charge a maximum spread of 4.0 per cent per annum to cover for any credit risk. The loans could have a maximum repayment period of ten years, enabling development of long-term industrial projects.

The scheme was a resounding success for borrowers, leading to approval of more than Rs435 billion of long-term loans spread over 628 cases. This implies an average loan size of Rs692 million, spread exclusively over large corporate entities. However, an average is often distorted by outliers, as certain groups were able to access more than Rs10 billion of financing for various group entities, skewing the distribution further.

In-effect, two dozen industrial groups were able to access a significant chunk of the concessional funds available at a weighted average spread of 1.0 per cent over the SBP refinance rate, implying a mark-up of 2.0 per cent per annum. As the mark-up was effectively fixed, and isolated from the broader interest rate prevailing in the market, a few dozen industrial groups were able to lock financing at a ridiculously low mark-up in the range of 2.0 per cent per annum.

The same has been calculated through a review of publicly available data of entities listed on the Pakistan Stock Exchange. For context, the prevailing policy rate as fixed by the SBP is 22 per cent.

Before the scheme was launched, long-term concessional financing made up 3.0 per cent of total private sector credit outstanding as of June 2019. Following introduction of TERF, long-term concessional financing jumped to make up 8.8 per cent of total private sector credit outstanding as of May 2023, almost tripling its share. During the same period, private sector credit increased by 34 per cent, wherein concessional financing increased by 293 per cent.

Effectively, one-fourth of growth in private sector credit was driven by concessional financing. Concessional financing increased from Rs157 billion in June-2019, to more than Rs616 billion in May 2023. The sudden increase in concessional financing led to a strong surge in imports, eventually contributing to a precarious current account position, as foreign exchange reserves and foreign currency liquidity eroded.

Looking at more granular data, it can be seen that almost 47 per cent of fresh concessional financing was extended to the textile sector, which saw its concessional financing increase from Rs117 billion in June 2019 to Rs331 billion in May 2023. There exists a case that increased availability of financing would have led to capital investments, eventually resulting in increase in exports. However, this has not materialized yet, as textile exports continue to stay flat, or drop on a monthly basis despite a depreciating Pak rupee.

It will take a few years to assess objectively whether the scheme actually resulted in any increase in exports, and whether the substantial concession provided was actually effective, and judicious use of concessions provided.

A deeper look into sectoral level data suggests that the scheme was devoid of any direction provided by a coherent industrial policy. As an example, the automobile industry got access to Rs19 billion of concessional financing, while also being a highly protected industry. The scheme effectively provided super low-cost capital to an industry that is already highly protected, and continues to fleece customers in terms of price increases, and mediocre quality of its products.

Similarly, the cement industry got access to more than Rs48 billion of concessional financing, making up almost 17.5 per cent of its total financing from commercial banks.

The cement industry continues to operate as an oligopoly, exercising strong control over pricing. Providing concessional financing to an industry that operates as an oligopoly, and does little exports given its true potential, makes no economic sense.

The decisions to extend financing were driven by commercial banks, who predictably extended credit to the usual industrial groups, with no regard for economic impact – since it is not the job of commercial banks to formulate or propagate an industrial policy.

The recent noise regarding making available names of beneficiaries of the scheme, and the SBP not being able to furnish these, is spurious at best. Most information is already available in the public domain. The issue largely is around the design, implementation, and evaluation of the policy. Relevant consolidated data in the public domain that can provide guidance regarding the success or failure of the scheme is essential for a transparent evaluation process. Similarly, the inability of the scheme to support SMEs, and restricting concessional support to those entities that already have surplus capital is also a consideration that needs to be evaluated.

The scheme needs to be evaluated in terms of impact on economic activity generated, incremental jobs created and incremental exports added. The inability to evaluate this would eventually result in a scenario where even the best of intentions and well-designed schemes would result in suboptimal outcomes. Instead of driving a witch hunt, representatives of the people and relevant public bodies should be demanding an extensive evaluation to assess, learn and improve from policy errors – rather than trying to find scapegoats.