With a growing financial industry and a host of new sectors set to develop, will Pakistan hold its own amid market slowdown and troubled domestic politics? Karina Robinson reports from Karachi.

Pakistan may only grab people’s attention when icons such as Benazir Bhutto are assassinated and stories about Al-Qaeda training grounds in the country’s North-West Frontier Province bordering Afghanistan hit the international ­headlines.

Lost in that negative coverage is the reality of a functioning economy, the fifth largest emerging market by population size, with a growing middle class of about 30 million people and myriad business opportunities, not least in the banking sector.

“There is a momentum which even the past 15 months of political turmoil has not brought to a halt,” says Ali Raza, chairman and president of National Bank of Pakistan (NBP), the country’s largest financial institution with assets of $12.5bn.

Prospects for profit

Foreign banks not only agree, but are excited enough by the profit prospects to be entering the country at a time of upheaval, while others are expanding existing operations. Malaysia’s ­Maybank announced in May that it would pay about $1bn for a minority stake in Muslim Commercial Bank of Pakistan, while the UK’s Barclays Bank received a banking licence in December and will launch operations soon.

Moshin Nathani, country head and managing director of Barclays, notes that Pakistan has a fast-growing and young population of 161 million and a rapidly increasing gross domestic product (GDP). He adds: “At the same time, its banking sector is underdeveloped; for example, it has only about 50 branches per one million people, versus about 200 in the UK. And we believe our brand will carry very well into ­Pakistan.”

Banking presence

Meanwhile, Standard Chartered Bank, which bought a local bank in 2006, has multiplied its branches so that it now boasts 174 in 39 cities, compared with 115 in 22 cities in January 2007.

And the UK-­headquartered bank sailed ahead with its plan during a year that saw uproar about the disputed presidential election won by General Pervez Musharraf, the dismissal of supreme court chief justice Iftikhar Chaudhry, emergency rule and the assassination of opposition leader Ms Bhutto.

In fact, despite the problematic return to an unstable democracy (see below), the main gripe from the CEOs of five banks at a round table organised by The Banker in Karachi was the training and retention of staff in a financial services market that has exploded during the past six years. “We are the main provider of human resources to other banks,” said ­Standard Chartered’s country head Bazar Kazmi, glumly.

Rising inflation

That is not to say that the benign ­scenario is continuing. GDP growth averaging 7.6% in the past four years is set to slow to about 6% this year while inflation has rocketed to 11% year on year on the back of food and oil price rises, and interest rates have rocketed. Muneer Kamal, CEO of KASB Bank, notes that the “fabulous spreads are not going to last too long. Banks have had it easy, lending to top corporates. There will be more defaults with high interest rates and [lessened] capacity to repay.”

This is certainly also true on the consumer finance side, which only took off five years ago but has already become a very competitive market. Some banks have been excessively aggressive in their offerings, and a rise in non-­performing loans in this area is one of the reasons that central bank governor Shamsad Akhtar forced banks to double provisions last year (for full interview see Bold governor strives for new frontiers).

Textile reliance

On the corporate side, banks are overly exposed to the textile industry, responsible for a significant 58% of ­Pakistan’s exports. Non-­performing loans are also rising in this area of business on the back of competition from China, India and Bangladesh. Zaf Usman says that he is looking to sell Usman Textiles as the family firm suffers a competitive disadvantage to its neighbours due to higher financing and labour costs, lower productivity and also the need to produce its own energy due to power cuts.

But even as the banking market becomes more challenging, it is worth noting that net interest margins remain at more than 5.5%, banks have recorded record profits for a number of years and several new areas look set to develop (see below).

M&A opportunity

Another opportunity lies in merger and acquisitions activity. “We have to position ourselves futuristically to have stronger, larger banks,” says Ms Akhtar. The State Bank of Pakistan has been raising minimum capital requirements. Banks will need a minimum capital of $100m by the end of 2009. It has also tightened the regulatory requirements and improved its ­supervision.

Ms Akhtar expects her moratorium on new conventional banking licences to aid the consolidation process, although she will allow a few more Islamic institutions.

During the past few years, privatisation means that 80% of the banking system is in private hands, which has led to improved management. The banking asset sale is likely to continue as the government needs to plug its budget deficit at a time when international capital markets are expensive and wary of Pakistan’s risks – Standard & Poor’s recently lowered the country’s rating to B on the back of fears about a growing budget and current account deficit and political uncertainty.

An additional and long-standing problem for state finances is the absurdly narrow tax base. Only about 1.6 million people pay taxes, which means that revenues from this source are severely limited.

Positive steps

The government recently reconstituted the Privatisation Commission – a positive move. It may well need to reassess how it privatises the remaining stakes in ­Pakistani banks, having been forced to postpone a global depositary receipt for an equity stake of 20% in NBP. The government still owns 75% of NBP and 42% of Habib Bank.

Although foreign direct investment and portfolio investment reached a record $8.2bn in the 2007 financial year to June last year, it is extremely unlikely to match this in 2008. With a current account deficit that looks likely to reach 7.3% of GDP for fiscal 2008, the sale of bank stakes to foreign strategic investors in order to bring in foreign currency may be on the cards.

HSBC has been mooted as a potential candidate as it remains a small bank in a market that would seem a natural fit, bearing in mind its Asian strategy and expertise. Citibank, admitted Arif Usmani, CEO of the bank in Pakistan, was at one time “flirting” with an acquisition but it is now too busy hunkering down on a worldwide basis.

More likely, perhaps, are institutions from the Gulf which are awash with funds and already involved in the Islamic finance sector in Pakistan. ­Chinese banks might also be a possibility as they seek to diversify their earnings and accompany Chinese firms in their government-led effort to buy farm- land abroad to bolster food security.

Global outlook

Pakistan is not immune from the unfavourable global outlook. The lack of a strong government adds to the burden at a time when the cost of oil and food has skyrocketed, government revenues look vulnerable and important decisions need to be made regarding infrastructure.

Nevertheless, credit to the private ­sector and non-financial public enterprises is only an estimated 28.3% of GDP, notes Standard & Poor’s, evidence of the growth prospects for financial ­institutions. Banks are braced for a bumpy ride, aided by strong profits from the past years and a vision of future profitability based on Pakistan’s still-to-be realised potential.

RETURN OF AN UNSTABLE DEMOCRACY

In the bustling commercial capital of Pakistan, the shenanigans of the politicians in Islamabad seem far away. Businessmen in Karachi, the largest city with an estimated 20 million people, would wish them even further away. “What industry wants is political stability,” says Naz Khan, CEO of asset manager KASB Funds. That looks unlikely.

As The Banker went to press, the unstable coalition between the Pakistan People’s Party (PPP), led by Ms Bhutto’s widower, Asif Ali Zardari, and Nawaz Sharif’s Pakistan Muslim League ­(PML-N), was in trouble. The PML-N said it was pulling out of the coalition but would support government policies.

There is speculation that Mr Zardari, convicted on corruption charges in 1999 and nicknamed ‘Mr Ten Per Cent’ for his role as an intermediary when his wife was in power, might want to assume the prime ministership after a by-election in May that would give him the necessary seat in ­parliament.

But bankers believe he is content to be the power behind the throne as co-­chairman of the party, while the PPP’s Yusuf Raza Gilani acts as prime minister, especially as he is not popular within the party itself. They also believe that Mr Zardari, following his stint in prison, is now intent on securing his legacy and preparing the ground for his son to assume the family mantle.

The PPP is proving itself willing to compromise with president Pervez Musharaff, while Mr Sharif’s vendetta against the former general who deposed him in 1999 shows no signs of waning.

What is noteworthy in a country that is often misrepresented abroad as a hotbed of Islamic extremism, is the decimation of the religious parties in the last election. They went from 59 seats in the 342-seat parliament to six, mainly because the electorates of the two provinces which they ran, Baluchistan and the North-West Frontier, were discontented with their general incompetence and failure to deal with law and order problems – reassuringly mundane reasons. That is not to say that the border areas are peaceful. They are out of the control of the legitimate government, awash with militants and training grounds for Al-Qaeda and the Taliban, according to security reports. The country’s tribal areas in the west are the site of Al-Qaeda’s remaining core leadership, says an April report from Europol, and suicide bombings such as that which resulted in the death of Ms Bhutto have soared.

However, the vast majority of Pakistan’s population lives under a peaceful, vociferous and imperfect democracy with a vibrant local press. The reality of Pakistan is as complex as the intricately embellished trucks and buses that ply the streets of its cities.

DEVELOPING AREAS IN PAKISTAN'S BANKING SECTOR

Consumer finance and corporate lending have been some of the steadiest sources of income for banks during the past few years. Agribusiness is another which, on the back of the commodities boom, looks likely to increase in importance.

“Agriculture has been one the most neglected sectors in Pakistan in the past 60 years. In India, the same soil yields two-and-a-half times more. Pakistan has some of the most arable lands in the world and with food prices the way they are, we can become, in the next three to five years, a major exporter of food,” says Ali Raza, chairman of National Bank of Pakistan.

Pakistan is importing wheat, while the quasi-feudal state of land distribution needs reform to boost productivity.

Zakir Mahmood, CEO of Habib Bank, which gathers 20% of its deposits from rural areas and is one of the largest providers of agrifinance, sees “a great future in the development and uplift of the rural areas of Pakistan. We continue to increase our reach to the population in these areas.”

Habib Bank is also leveraging its position as the largest provider of transfers from ­Pakistani workers abroad – remittances are a significant source of foreign exchange for the country – to sell saving schemes and other asset products to the recipients.

Pakistan’s desperate need for energy infrastructure provides opportunities for banks such as United Bank, the third largest by assets. Its CEO Atif Bokhari is looking for ­continued growth in the bank’s corporate loan book from independent power projects.

The bank expects its foreign operations, mainly in the Gulf Cooperation Council, to make up for the expected slowdown in the domestic market. One-quarter of its profits come from abroad. Having said that, loan growth in Pakistan is still between 15% and 18%, he notes, compared with 21% in 2007.

United Bank has a couple of branches dedicated to Islamic finance and is still evaluating their performance. Central bank governor Shamsad Akhtar notes that Islamic finance is responsible for 3% of the banking sector. She expects this to rise to 15% in a few years, backed by the central bank’s institutional framework and nurturing of the sector.

Bankers are not sceptical of this ambitious target: “Islamic banking has been growing in quantum leaps,” says Standard Chartered’s local CEO, Badar Kazmi. The bank has seven dedicated Islamic branches and is planning up to 15 more by December 2009.

Similar to the other banks, it is working on expanding its small to medium enterprise business. SMEs are responsible for an estimated 30% of Pakistan’s GDP and Standard Chartered, says Mr Kazmi, has a total of 4% of the SME ­market.

Meanwhile, Governor Akhtar says that she is in the midst of reflecting and consulting on a second generation of banking reforms which should see more sources of business open up to the banks.

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