Financial inclusion and poverty

Private investment in Pakistan is low. What are the factors behind such a low rate of private investment? One doesn’t need to be a rocket scientist to figure out the reasons. Some of the obvious reasons for low private investment in the country are terrorism, a poor law and order situation, political and economic uncertainty.
Availability of finance is also one of the main factors behind low private investment and sluggish economic growth. Commercial banks feel more secure in retaining public securities as the government borrows very frequently. Capital markets, which can channel the savings to productive investments, have not been developed. Moreover, availability of finance for investors and entrepreneurs is not an easy job.
Weak financial intermediation, high collateral requirements, and financial illiteracy are the biggest stumbling blocks to the availability of finance in Pakistan especially for the small and medium enterprises. Financial exclusion is high. According to an ADB working paper ‘Financial inclusion, Poverty, and Income inequality in developing Asia’ published recently, Pakistan has been ranked 134 out of a total of 176 countries. Countries like Indonesia, India, and Malaysia have respectively been ranked 102,104, and 41.
Pakistan initiated some structural reforms during the 1990s in the banking sector but in terms of access, the banking sector leaves much to be desired. Most of the population still does not have access to banking services, especially in the rural areas. The high interest rates do not appear to be a binding constraint but high intermediation costs – evident from high interest rate spreads – are a real problem. The lending rates are comparatively high due to preference of the commercial banks to hold public securities. Deposit rates are low as deposits are generally held in the banks for transactional purposes and banks as such do not attract savings of the people. Banking spreads are persistently high.
The lending-deposit interest rate spread is a good measure of financial efficiency of banks. Large interest rate spreads in Pakistan are driven, among other factors, by the opportunities for the banks to earn income from non-core business activities. Moreover, Pakistan’s monetary policy is operating in an environment where fiscal deficits and government debts are increasing and the government has continuously borrowed from the central bank
Domestic financial constraints in Pakistan are also driven by lack of financial depth. An average Pakistani household is still outside the formal financial system and does not use the banking system for depositing their savings. Over half of the population saves but only eight percent entrust their money to the country’s formal financial institutions. One-third of the population borrows but only three percent use formal financial institutions. Microfinance has grown in the last one decade in Pakistan but out of about 80 million adults, microfinance access extends to only 1.7 million. About half of the population uses informal sources of credit where interest rates charged are generally exorbitantly high.
SMEs are considered to be the growth engines of the economy as they provide jobs, foster entrepreneurship, and provide depth to the industrial base of the economy. But SMEs get a disproportionately small share of credit relative to their contribution to the overall economy of the country. According to World Bank estimates, there are over 3.2 million SMEs in Pakistan which constitute about 90 percent of the private enterprises in the industrial sector, employ nearly 78 percent of the non-agriculture labour force, and contribute over 30 percent to the GDP but receive about 16 percent of the total lending to the private sector. Massive borrowing – by the government – from the scheduled banks has also crowded out the private sector. For example, according to State Bank of Pakistan, during six months of the current fiscal year, credit to the private sector has decreased by 37.6 percent over the corresponding period of the last year.
According to the World Bank study economic and cultural factors like poverty, financial illiteracy, and religious beliefs also hinder access to finance. Resultantly, most of the individuals and small firms use informal sources of borrowing rather than having to resort to financial institutions. Undoubtedly, weak financial intermediation, low financial inclusion, and reduction in the credit to the private sector are big problems and need to be addressed through structural reforms and policy initiatives.
Foreign remittances have always been a big source of finance as far as Pakistan is concerned and the role of remittances in our macroeconomic stability cannot be downplayed. But the exogenous sources of foreign funds have not translated into productive investments. Generally, such flows ended up in real estate with a resultant surge in real-estate prices. Pakistan is perceived to be a high risk country due to terrorism and security issues. According to the Global Competitiveness Report 2014-15, Pakistan was ranked 139 out of total 144 countries against the indicator of ‘business costs to terrorism’.
Private investment has declined by 1.6 percent in real terms in 2013-14. A large fall of 27 percent was observed in the large-scale manufacturing sector. Also, despite the signing of many agreements and MOUs, investment in the power sector has declined by over 9 percent. As per one World Bank paper: “The reduction in external inflows has aggravated internal and external financing issues. Pakistan has increasingly relied on monetary and central bank financing of the current account and fiscal deficits. The diversion of commercial financing to government bonds issued to finance the fiscal deficit has reduced credit for the private sector, which has particularly affected SMEs and women entrepreneurs”.
Concern about finance, however, also reflects other constraints on borrowers, constraints that are not necessarily linked to the financial system. For example, access to finance, especially for smaller firms, is constrained due to financial illiteracy and limited capacity to produce necessary documentation like business plans, licences, titles for collateral etc.
Availability of credit is one the constraints to economic growth in Pakistan and poverty reduction in Pakistan. In order to ameliorate the situation, we need to work on several fronts. Banks need to be made more efficient at channelising savings, especially from the rural areas. They need to invent new products to make the access of financial services easy.
“Stashing money in mattresses puts it at the risk of being stolen and means it neither accrues interest nor gets used more productively through lending, as it would be if it were in a bank. When money moves around it does so as cash, fuelling crime and staying beyond the reach of tax collectors” wrote the Economist in one of its reports on financial inclusion.
Financial inclusion is also highly important for poverty reduction. In a recent blog on financial inclusion, Jim Yong Kim – the president of the World Bank – wrote: “People who are unbanked struggle to save, plan for the future, start a business, or recover from unexpected losses. Small businesses without access to affordable financial services or credit cannot acquire capital to invest, grow, and create jobs.
“Financial access provides the building blocks people and businesses need to manage their economic well-being, and promote savings, investment, job-creation, and growth. Financial access also empowers women by making it easier for them to build wealth and create small businesses”.
The writer is a graduate of Columbia University.
Email: jamilnasir1969@gmail.com
Twitter: @Jamilnasir1