In mid-September, during an auction held for borrowing, the government rejected all short-term loan offers. Banks were demanding interest rates of 17% or higher for these loans. By the auction at the start of October, banks had lowered their offers to around 14%, but the government exercised more caution and rejected all offers for three-month treasury bills. In just two sessions of not borrowing, commercial banks were forced into a difficult position. Habib Bank alone has 4 trillion rupees sitting idle, but they lack a major client to whom they can lend and earn interest.

The banks’ arrogance lasted just these two sessions. The moment the government stopped borrowing from commercial banks for just one month, their swagger disappeared. Now banks are searching for private clients, but none are to be found. Smart clients know that interest rates are expected to fall further, so why would they take loans now? On the other hand, banks previously gave the most loans for car financing, but now car manufacturers themselves are offering installment plans, and some are even offering them interest-free. What will banks do with these billions of idle funds?

Before December, the government has some loans to repay, for which it will need new loans. In such a scenario, the government could have considered borrowing only from the State Bank for a few months and sidelined private banks, but recent legislation has declared borrowing from the State Bank as forbidden. Meanwhile, the IMF’s Geeta Gopinath’s watchdogs are keeping a very close eye. Hence, borrowing from the State Bank is almost off the table, but the government can adopt a minimum borrowing policy for some time.

If the government acts wisely and limits borrowing to absolute necessities, interest rates could drop into single digits before December. But the government’s finance minister is also a former banker, so how far will he go to hurt his former industry?

Not only do banks have enormous funds at their disposal, but they also face the threat of penalties from the State Bank. If a bank’s advance-to-deposit ratio falls below a certain limit, the State Bank can impose hefty fines. But whom should the banks lend to? No one is willing to take loans.

If the government refrains from borrowing from commercial banks for the next two months, believe me, banks will beg to offer loans at 8% interest. However, there is also a risk in this situation: extremely cheap loans could encourage people to make luxury purchases. If this happens, the burden on imports will increase, putting pressure on the dollar, which could lead to another wave of inflation. To avoid this, the State Bank will need to use its powers wisely. The State Bank can issue prudential regulations for commercial banks.

My suggestion is that the State Bank should instruct commercial banks that consumer loans should not exceed 15% of total loans, and the minimum interest rate on these loans should be KIBOR +8. For business loans, the instructions could be that the interest rate should not exceed KIBOR +4, and at least 30% of total loans should be allocated for business purposes. If the State Bank issues such guidelines, business loans would be clearly prioritized over consumer loans. Increased business activity would result in an increase in overall supply, helping to reduce inflation.

The situation demands that the government take the minimum possible loans so that banks are forced to lend to the private sector, and the State Bank should make loans easier for businesses by using prudential regulations. If the government adopts such measures, the interest payments on domestic loans for the current year could be reduced from 8,700 billion to 7,000 billion rupees, and inflation could hover between 5% and 7%. But if the government resumes heavy borrowing, banks’ business will continue to thrive as before, and the public’s difficulties will only prolong.

By Dr Atiqurehman