Pakistan, an economy burdened by significant debt, is witnessing an unexpected boom in its banking sector. Recent months have seen Pakistani banks posting impressive profits, even surpassing their counterparts in Asia, as reported by the Financial Times. This surge in earnings is directly linked to the high interest rates implemented over the past two years to combat inflation, which reached a peak of 38% in June 2023. These rates have propelled the banks to capitalize on the lucrative government debt market, effectively turning Pakistan’s debt crisis into a windfall for its financial institutions.
Statistics paint a clear picture: seven of the 15 banks in the Asia-Pacific region boasting the highest second-quarter returns are based in Pakistan, including prominent players like Standard Chartered Pakistan and Bank Alfalah. The banking sector’s after-tax profits almost doubled to Rs 642.2 billion ($2.3bn) in 2023. This trend is directly attributable to the government’s aggressive interest rate policy, exceeding 20% in recent years.
Experts attribute the banks’ thriving performance to the high returns generated from government debt. “Where there was an opportunity for higher returns, they were capitalised on,” explains Rehmat Hasnie, chief executive of the National Bank of Pakistan. Mattias Martinsson, chief investment officer of Tundra Fonder, further emphasizes this point, stating “When you have these difficult times, you know interest rates go up and they will basically compensate for a depreciating currency.”
However, this seemingly positive situation is underpinned by a precarious reality. Pakistan’s total debt-to-GDP ratio surpasses 74%, with domestic debt, largely held by commercial banks, soaring to over Rs 43 trillion as of March 2024. This equates to nearly half of the country’s GDP, a significant increase from Rs 11 trillion a decade ago. Government borrowings for budgetary support reached Rs 29 trillion by the end of June 2024, almost double the Rs 15 trillion borrowed three years prior. This heavy reliance on government debt has resulted in banks’ sovereign exposure exceeding 54% of total assets, a figure considerably higher than the average for emerging market economies.
Pakistan’s precarious financial position has forced the government to seek restructuring of its domestic debt and rely on IMF bailouts. The country has already secured nearly two dozen IMF loans since 1958, most recently securing a three-year, $7 billion loan deal this month. The government’s attempt to manage its fiscal deficits by increasing taxes on bank profits highlights the complex and strained relationship between the state and the banking sector. Income tax expenses for banks last year amounted to almost 50% of their profit before tax, with the banking sector paying a hefty Rs 618 billion in income taxes in 2023, double the amount paid the previous year.
This reliance on bank funding for government deficits has raised concerns about the private sector’s access to credit. Domestic credit to the private sector in 2023 was under 12% of GDP, a significant decline from 24% in 2008. Experts argue that the government’s debt is considered risk-free, making it more appealing to banks than potentially riskier private sector lending. While banks claim their recent profits will allow them to increase lending to the private sector, the current economic conditions and structural challenges present significant hurdles. The potential for increased private credit supply remains uncertain, given the unstable economic environment in Pakistan.
The country’s banking sector has transformed Pakistan’s economic crisis and high government debt into a lucrative opportunity, capitalizing on high interest rates and government securities. However, this comes at the cost of limited private sector lending, raising questions about the long-term impact on economic stability and growth. The risk of default and the ongoing need for IMF support further highlight the fragility of Pakistan’s economic landscape.
