Credit greases the engine of economic growth. In particular, loans to private-sector businesses are considered a mainstay of the modern economy: credit lets private-sector businesses invest in new plants, machinery, inventory and human resources. New jobs are created, consumption goes up, and so does the GDP.
In contrast, slow growth in private-sector credit uptake leads to fewer jobs, limited expansion in businesses and stagnant income levels.
In short, credit is the oxygen that keeps the economy going.
So what should one make of the fact that banks’ credit to the private sector as a percentage of GDP has dropped by nearly half post-2009?
Of course, GDP growth has been far from satisfactory for the last six years. But what about the profitability of large private-sector companies that are typically the primary recipients of banks’ credit?
Conventional wisdom suggests that the drop in domestic credit – financial resources that deposit-taking entities have loaned to the private sector – is reflective of the unprofitability of large, private enterprises. Why else would banks hold back credit and forego future interest income, after all?
But that is hardly the case with large Pakistani companies, official statistics show.
In a comparative assessment of corporations in light of credit to the private sector released on July 1, SBP economist Talha Nadeem used Bloomberg data to study a total of 68 large, non-financial corporations (NFCs) based on their total assets from Pakistan, India and Sri Lanka.
The study concludes that the shortlisted Pakistani NFCs have generated “impressive returns” over the analysis period – particularly post-2011. The key measures that Nadeem used to arrive at this conclusion are return on assets (ROA) and return on common equity (ROCE) ratios – two of the best determinants of corporate profitability.
In fact, Pakistan’s largest NFCs have performed better than their counterparts in India and Sri Lanka in terms of both ROA and ROCE, the study reveals.
“Essentially, these profitability ratios dispel the notion that large Pakistani NFCs are not performing well. In fact, such firms have, on average, consistently posted strong returns in the last few years,” Nadeem says.
This leads to a basic question: why are these large NFCs not taking out more bank loans for rapid expansion if their returns have been so high?
The answer lies in Pakistani companies’ penchant for ‘deleveraging’. In simple words, deleveraging stands for paying off debt or borrowed money and increasing the reliance on equity instead.
By using the debt-to-common equity ratio, the study shows that many large Pakistani corporations have opted for deleveraging in the last six years.
This means Pakistani companies have been paying off their past bank loans since 2009 while resisting the temptation to borrow for further expansion. Interestingly, the study shows the shortlisted Indian and Sri Lankan firms are more leveraged than their Pakistani counterparts.
The study says large Pakistani companies are increasingly opting for “inter-corporate financing” instead of borrowing from banks. In essence, inter-corporate financing involves a holding company making equity investments in its subsidiary as opposed to the subsidiary taking out a traditional bank loan.
It reveals that “long-term investments” of private firms rose from an average of 5.4% in 2009-12 to 7.3% in 2014 as a percentage of their total assets. Conglomerates with substantial inter-corporate financing include Fauji Fertilizer, PTCL, Engro Corporation, Hubco, Nishat, Packages, Ibrahim Fibres, Attock Refinery and Lucky Cement, according to the study.
“The deleveraging trend in particular has increased the future potential appetite for credit by NFCs in Pakistan,” it says, adding that there may be “significant and quick growth spurts” should commercial banks tap into the demand for credit by niche segments like SMEs and housing finance.
Published in The Express Tribune, July 4th, 2016.