Note from the editorial board Record inflation and the journey there

April saw more of the punishing inflation characteristic the last couple of years, with a record 36. percent rise year-on-year. The month’s increase was 2.4 percent, and the year-on-year inflation last month was 36 percent, marking the 11th month since last June that inflation was above 20 percent. The economy is not heading into hyperinflation yet. Hyperinflation is defined as over 50 percent a month. That works out at several quadrillion times a year. That is then prices change on an hourly or daily basis, not weekly or monthly.

What has made this inflation so unbearable is that it is accompanied by low growth. An indication of this came in the monthly trade figures, which showed that the trade deficit in the first nine months of 2022-2023 had shrunk 39.62 percent from $39.3 billion to $26.7 billion. This does provide some relief to economic managers worried about where to make the next payment, but it has not been achieved because of some mighty surge in exports, which have indeed shrunk 11.2 percent from $26.2 billion to $23.3 billion. Imports declined 28.4 percent from $65.5 billion to $26.9 billion. The trade volume thus shrank from $91.7 billion to $50.2 billion.

That decline in commercial activity implies a severe contraction, especially in an economy where export sales lead growth. Not only are households losing their sources of income, as breadwinners become jobless, but that bread goes out of reach. The inflation news was bad enough, but the hike was on the basis of high food inflation. Not only do households have to handle loss of income, but pay more to put food on the table.

One of the main difficulties is that the path out of this lies in a massive expansion of exports, which have shrunk. That is not going to happen. The import bill can only fall so far, with the decline in the global oil price likely to translate into benefits for Pakistan. However, a disturbing fact has been the failure of consecutive interest rate hikes to tame inflation. They have probably led to contraction, and thus stagflation. The experience of half a century ago shows that interest rate hikes to tame inflation may well have caused the stagflation characteristic of the era. Interest rate hikes are always bad for business, and are a really bad idea if they don’t work either to tame inflation. The IMF wants to suggest them. The government must not fall for this, as it reflects a lack of solutions.

What it must also do is reflect. There is much that is wrong with Pakistan’s economy, and little can be achieved in the short-term by going over where the rot started over the past 75 years. But it is worth looking at where these more than seven-decades as a nation state have brought us, if not why they have brought us to this point.

Pakistan’s Human Development Index value for 2021 is 0.544— which puts the country in the Low human development category—positioning it at 161 out of 191 countries and territories. Between 1990 and 2021, Pakistan’s HDI value changed from 0.400 to 0.544, a change of 36.0 percent. The great irony of this, of course, is the fact that this index on which Pakistan finds itself slipping fast was in fact developed by a Pakistani — Dr Mahbub ul Haq, who created HDI in 1990. The index was then used to measure the development of countries by the United Nations Development Program (UNDP).

Meanwhile, the Gender Development Index (GDI), which measures gender gaps in achievements in three basic dimensions of human development: health, education, and standard of living, shows a massive gap. The 2021 female HDI value for Pakistan is 0.471 in contrast with 0.582 for males, resulting in a GDI value of 0.810, placing it into Group 5, making it part of an unenviable group of countries that includes Ethiopia, South Sudan, and Afghanistan. Meanwhile on the Gender Inequality Index, Pakistan ranks 135 out of 170 countries.

In 2021, the World Justice Project’s Rule of Law Index ranked Pakistan 130 out of 139 countries. Pakistan ranked second-last in South Asian countries behind the likes of Nepal, Sri Lanka, India, and Bangladesh. Only Afghanistan was ranked lower. In particular, the report showed Pakistan doing badly in the areas of corruption, fundamental rights, order and security and regulatory enforcement.

Just this year, Pakistan fell by 12 places on an index of media freedom. Pakistan was 145th on the 2021 index and fell to 157th on a list of 180 countries in 2022. The report noted that despite changes in political power, “a recurring theme is apparent: political parties in opposition support press freedom but are first to restrict it when in power”. The report also claimed that the “coverage of military and intelligence agency interference in politics has become off limits for journalists”. On the economic front, matters have not been much better.

None of the indicators paint a pretty picture. Human development in Pakistan has taken beating after beating. Political turmoil has left the country without any stable government, making the government of Pakistan a dodgy business partner. Consistent security failures and the inability to protect our own citizens means that the possible potential of Pakistan as a tourist destination, something other South Asian countries like Malaysia, Thailand, Vietnam, and Indonesia have done successfully, has been squandered.

And on top of all of this, Pakistan now faces the major crisis of climate change — which is perhaps the single most relevant and dangerous threat to our national well-being. According to the Center for Global Development, developed countries are responsible for 79% of historical carbon emissions. Yet studies have shown that residents in least developed countries have 10 times more chances of being affected by these climate disasters than those in wealthy countries. Further, critical views have it that it would take over a 100 years for lower income countries to attain the resiliency of developed countries. Unfortunately, the Global South is surrounded by a myriad of socio-economic and environmental factors limiting their fight against the climate crisis.

This year has seen Pakistan receive a bumper crop of wheat. While this is a cause for immediate happiness, we must also face the sobering reality that this year has seen an excess of rains and cooler temperatures that have come from climate change. While we are reaping the benefits for now, there is no telling where weather patterns will take us this monsoon season. Far from being prepared for such events, Pakistan is far from out of the crisis caused by the 2022 floods.

The sheer immovable force of climate change was painfully displayed last year. There was a gargantuan increase in the amount of monsoon rainfall that Sindh and Balochistan have seen this year. The two provinces saw the highest amount of water fall from the skies in living memory, recording 522 and 469 per cent more than the normal downpour. All in all, according to the latest report of the Post-Disaster Needs Assessment (PDNA), Pakistan needs at least $16.3 billion for post-flood rehabilitation and reconstruction. The PDNA report, released by the representatives of the government and the international development institutions, calculated the cost of floods at $30.1 billion – $14.9 billion in damages and $15.2 billion in losses.

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By: Bakht Noor

Every five years all over the country federal and provincial governments with the help of police, military personnel and other government functionaries band together to undertake a massive exercise: counting how many people there are in the country and where they live.

This constitutionally mandated activity determines some of the most important elements of our Republic. It determines the delimitation for federal and provincial legislatures as well as providing important and useful data that is used across various levels of government to formulate policy and aids an even wider variety of research in the private sector.

Yet almost every time this exercise takes place, it is mired in controversy and bad-blood. Profit sets out to explore what this census is, how it is conducted, and what the issues surrounding it are.

Let’s start with the basic question, what is a census?

“Acensus is a survey of all citizens of the country in order to accurately enumerate the population. ” explains Dr. Ali Hasanain, Professor of Economics at the Lahore University of Management Sciences (LUMS)

This brings us to the next question. Why on earth would we conduct the painstaking task of recording data of the whole population?

The answer is fairly straightforward. “The census is intended to improve the accuracy with which we understand who lives where. A key objective of this is being able to determine how many eligible voters live in each region of the country.” Dr. Hasanain elucidates.

“Theoretically, we should already have perfect registration of births and deaths. After that, it’s a trivial calculation to determine who is currently an eligible voter. In devel- oped countries, where records of births and deaths are very carefully maintained and updated, administrative databases are increasingly relied on for the census exercise” adds Hasanain. “Obviously no country has a perfect record, but while NADRA’s records are generally well-regarded, our system remains considerably weaker than developed countries’, as many people lack CNICs. Therefore, the census exercise remains important.”

The Research Methodology

That being said, the research methodology of conducting census surveys is generally the same across the world, as a census basically needs to remunerate every single individual that’s residing in a country.

“The only thing different for the census this time around in Pakistan is that it’s being conducted digitally. The tablets for remuneration and data are being collected in real time,” said Dr. Umair Javed, a professor of Sociology and Political Science at LUMS.

So, how does digital data collection work?

“Data is collected in a tablet, which then transfers the data to the census office. Data is tabulated there and consequently, the results come out quickly,” explained Dr. Javed.

With the new digital system, there are questions about whether or not the officials are trained to use tablets.

“There are some slippages there, but the greater issue of census recording in Pakistan has been either under-counting or over-counting in particular areas for political purposes,” concluded Dr. Javed.

There is another positive aspect about the census being conducted this year. Dr. Muhammad Saleem, an economist, shared a personal example to demonstrate this.

“I come from Swabi but am presently living in Islamabad. If you are living in a city for 6 months or longer, you are counted as its resident under this census. Figures haven’t been released yet but you’ll notice a higher population of Islamabad in the latest census results. I personally know many people who, though based in Islamabad, were counted as residents of their towns and villages according to the 2017 census. The research methodology of the new census seems more accurate”.

Other problems with the census

There can be serious logistical issues as well in conducting the census, according to Dr. Javed. “Sometimes, it’s genuinely hard to count far-flung populations. People are often living in logistically remote areas. This has historically been a problem in both the North West province (ex FATA region) and Balochistan. That’s why conventionally, people consider census estimates in Pakistan to be about 90% of what the actual population might be.”

There is another drawback too.

“The time frame to complete the census was announced but the deadline has been extended 3-4 times now. The Pakistan Bureau of Statistics (PBS) should have taken the provinces on board and collaborated with them to complete this census. There is a probability that they might have missed this step, which is why extensions and reverifications are continuously happening. This should not have been the case,” informed Dr. Saleem.

The Relationship between census and elections

According to Dr. Hasanain, the census helps the country track births and deaths. Typically when people die, adequate records of their deaths are not made.

“A database of who is a potential voter is going to have inclusion and exclusion errors,” Dr. Hasanain elaborated.

An inclusion error is when someone has been included as an active voter by mistake. This usually happens in circumstances where someone has passed away but the database has not been updated and he or she is still registered as a voter. An exclusion error, on the other hand, is when someone of eligible voting age is not registered as a voter.

“Errors occur everywhere. It is the degree to which the national database is erroneous that the country needs to control.” Dr. Hasanain asserted.

On a purely apolitical level, the purpose of the census is to make data corrections. However censuses are typically highly politically salient and people often resort to strategic behavior. You try to exclude people who are unlikely to vote for you and include people who are more likely to vote for you.

“If you have access to someone’s CNIC, you can resort to ballot stuffing which pushes fake votes into the system. A CNIC number is required for this to prevent people from cross-checking whether voters’ CNICs are fake or authentic. Election fraud becomes relatively convenient when the CNIC is authentic because it is presently hard to verify at scale whether the thumb print is that of the actual CNIC holder,” he detailed.

“If you have the CNICs of a few thousand dead persons, you will assign some people to continue imprinting their thumbs and register fake votes, if you’ve captured the polling booth. This is one way in which election rigging happens. You make sure that you’re not excluding people who should have been removed from the list of registered voters by virtue of their death.”

This practice can acquire other modulations as well. For example, let’s assume that political party X is not popular amongst the young population as opposed to party Y, which presents itself as a youth oriented party. Party X will therefore try to prevent the

What is delimitation and how is it done?

One of the key functions of any census, particularly in a parliamentary democracy, is the allocation of halqas’ or constituencies. These are the basic units that make up the patterns of any republic that is governed by the will of its elected representatives.

The goal of delimitation, or halqa-bandi, is to divide up the country into equal parts by number of people. So, each of these parts is an area, that is called a ‘constituency’, which will have, on average, an equal number of people residing within it.

By rule, the delimitation process takes each district as a territorial unit and the demarcation of constituencies is begun from the northern end of each district. After the ECP releases provisional delimitation maps, the public has a chance to make objections and propose revisions before the delimitation is finalised.

The number of people per constituency should be on average equal for all 272 constituencies, with allowance for 10% variance. Meaning that every district can have 10% more or less population than the average number. During the last delimitation process, which was done right before the 2018 general elections, the average population per constituency was calculated at 779,886 based on the 2017 census data.

Each constituency is represented by a seat in the National Assembly (NA). The equal number of people per constituency means that each seat in the assembly holds the same weightage of representation. So each member of the NA that is directly elected has had the chance to be chosen by, on average, the same number of people, so that every citizen’s vote has equal power.

Reading this, you may wonder: how will the proposed overseas voters figure into this. But that and the fate of electronic voting machines is yet to be decided and the ECP itself cannot predict the future.Delimitation is done separately for general and provincial elections. For the purpose of this story, we’ll focus on general elections – the round of elections that determines who sits in the country’s National Assembly.

There are a total of 272 seats in the NA for which members are directly elected through elections held in each constituency. So, the codes NA-256, NA-34, that is different for your voting station versus your friend’s, who is residing in another district or city, is actually the number of the National Assembly seat that will represent your constituency. In this way, you get to directly vote for who sits in one out of 272 seats in the NA. The total number of seats in the assembly is actually 342 when the 70 reserved seats for women and minorities are added. However, due to the merger of FATA into KP, the seats for directly elected members has reduced to 266. Hence, the need for a new delimitation.

young demographic from voting by making it harder for new voters to register.

This increasingly happened in Karachi in the 2018 general election. “Residents are often not counted as part of the population, and enumerators are told to stay away due to political reasons,” said Dr. Javed.

An additional concern has been raised this time.

The population in Balochistan has increased by 60% in the inter-census period, which is between 2017 and 2022. “This can mean two things: Either the 2017 census horribly undercounted the population in Balochistan or there has been tampering with the census results this year- ostensibly for political purposes,” highlighted Dr. Javed.

The census has concrete implications for how the national assembly seats are allocated in Pakistan. With the current count, Balochistan is attempting to acquire seven more seats in the national assembly. This substantiates that there are clear implications insofar as elections and political outcomes are concerned.

“A census is like any data collection exercise, and data is important for any policy making.The census holds data pertaining to housing, education, literacy and access to education. It can be used in different ways to create informed policy. The most immediate impact on the political domain though, as it’s directly linked to how the distribution of the national assembly constituency takes place between the provinces,” emphasised Dr. Javed.

For example, the number of seats in the parliament is now fixed at 266. This used to be 272, until FATA lost 6 seats. These 266 seats now have to be divided amongst provinces based on the number of population housed within each province. With the results coming in, Punjab stands to lose 7 seats from its total with one seat going to Sindh and 6 to Balochistan. The political implications of the census are therefore more overt.

There is yet another important political implication of the census. According to Dr.

Javed, once a census is released and its results gratified by the Council of Common Interests, the election commission of pakistan is bound under the constitution to carry out delimitations under census results.

“This might have implications on when elections can be held and if they can be held on time,” summed up Dr. Javed.

Economic relevance of census

The census has profound economic implications. According to Dr. Javed, having useful data that covers the entire population is central to how economic and social policy making is done in the country.

The most substantive economic relevance of the census is in terms of the National Finance Commission Award (NFC), according to Dr. Saleem. The NFC award was enacted in 1951 to regulate financial imbalances and manage financial resources between the center and the four provinces.

“The funds for MNAs and senators are contingent on the NFC award,” said Dr. Saleem. “The quota for government jobs is also assessed on the basis of population numbers.” All of this stresses the importance of census data.

How is the NFC share for each province determined?

NFC takes into account several key factors: the population of each province, its tax and fiscal effort/revenue, poverty/ income-distance, area/inverse population density, demographic performance, and forest and ecology.

In Pakistan, the NFC share for each province is predominantly measured in terms of the population number based within that province. In fact, population number carries 82% weightage in the NFC award.

“When the population of one province grows more than other provinces, its share in the horizontal distribution of resources under the NFC also increases,” said Dr. Saleem. This means that provinces have an incentive to overcount their populations in order to have a greater claim on the NFC award. This happens to be the most profound problem with the NFC award in Pakistan. “There are other federation systems in the world. To reduce intra province disparities, the NFC share is mostly based on the relative income distance or poverty between provinces,” added Dr. Saleem.

In India for example, 45% of the NFC award is based on poverty/income distance and only 15% on population. In contrast, in Pakistan only 10.3% of the NFC award is based on poverty/income distance while 82% on population. This means that an overwhelming share of the NFC award in India is distributed according to the relative poverty of each province.

The situation in Pakistan was even more abysmal prior to 2010. Dr. Saleem provided some historical context, “until 2010, the resources were distributed amongst provinces solely on the basis of their population numbers. Finally, the multiple indicator NFC award was introduced which took into account a plethora of factors such as relative poverty, population density, revenue generation, and so on and so forth. This explains why the population majority province of Punjab has historically been recipient to most of the resources. Hence, Punjab has experienced more development while the remaining provinces are relatively poorer.”

Now even though a multiple indicator is in place for deriving the NFC share, the 82% weightage on population is still inexplicable and sort of bizarre.

How can the NFC award be made non-controversial in Pakistan?

According to Dr. Saleem, there are two solutions to this problem.

“Firstly, there should be more effective devolution of power. Provincial autonomy should be increased- financial, administrative, in whichever form. The 18th amendment of our constitution guarantees this. However, according to the World Bank report released last month, devolution is not effectively being implemented. Provinces have only received one-third of the autonomy that they were supposed to receive,” delineated Dr. Saleem.

“The second solution is to reduce the population weightage within the NFC award,” he adds. “We should increase the weightage of other indicators, like India for example. Other factors can also be considered. For example, these days Punjab is progressing in terms of population control. We can incentivise provinces to make efforts to control their population by increasing their NFC share. This will lead to competition amongst provinces for population control.”

Dr. Saleem also had an intriguing anecdote to share with regards to this.

When the census occurred in 2017, preliminary results were announced in 2018. They depicted an alarming surge in population compared to the previous census that had been held in 2018. There was a lot of protest and media outrage against the dramatic population increase, and comparisons were drawn with India and Bangladesh that had taken decisive measures to control population growth.

One person was particularly appalled by the result. Saqib Nisar, the Supreme Court Chief Justice at the time undertook suo moto action to probe into the matter. He construed this as a human rights issue, summoned governments of the four provinces and discussed strategies.Stakeholder suggestions from both the civil society and government were garnered. As a result of the ongoing conversations, a Federal Task Force was created in 2018 for the purpose of population control.

The Federal Task Force created a fund in which PKR 10 billion was deposited. The provinces were allocated funds to control their populations. However, the plan backfired terribly.

“You see, the provinces are not stupid. Their NFC share is dependent on the amount of population they have. You’re giving them funds without offering any real incentives to control the population. The provinces fear that their NFC share will decrease if their relative populations stagger in growth. Hence, they acquire the funds without taking any meaningful action,” concluded Dr. Saleem. n

By @2paisay & Mariam Umar

Step 1: [This step is only applicable to Development Finance Institutions (DFIs) and other non-banking financial institutions (NBFIs) that can accept deposits,so move directly to step 2 if you are a normal business]

Get commercial banks and money market funds (mutual fund companies that invest most of their money in government bonds, but also keep some of it in cash) to either deposit their cash holdings or place money (Letter of Placement, Certificates of Deposits) with you.

Step 2: Use the funds received in Step 1 (in case of NBFI/DFI) or any excess funds that are already available with the company (in case of a non-financial corporate) to purchase units of money market funds or short-term government securities i.e. T Bills. You could also buy long term government securities i.e., PIBs s. Just make sure that PIBs are floaters, i.e if interest rates increase, your return should also increase.

Step 3: Now pledge your units of money market fund or the government securities with commercial banks to borrow money against these. Banks will happily lend you at very low rates as this lending is secured by the two of the most liquid collaterals in the country i.e.

1. Highly marketable and credit risk free Tbills and PIBs issued by Government of Pakistan and

2. Money Market Funds that mainly invest in aforementioned TBills and PIBs.

But if you have a DFI license, go to Step 3b as it offers even cheaper loans.

Step 3b: Use the Government of Pakistan securities to borrow from the SBP directly through a repo (recently made available to DFIs only). The rates offered by SBP for these loans are almost always lower than the rates charged by commercial banks. .

Plan such that the tenor of your borrowings (whether through commercial banks or SBP) is longer than the duration of your investments.

Step 4: Now use this newly borrowed money to buy more government securities (or units of money market funds).

Step 5: Go back to Step 3

Step 1 and Step 2 are there just to kickstart the process. The exponential growth comes from continuously cycling through steps 3 to 5 i.e. buy-pledge-borrow. U Microfinance Bank (Ubank) has been able to double the size of its balance sheet in a year, and it has been successfully doing this for the last few years, while Pak Kuwait Investment Company (Pak-Kuwait), Pakistan’s largest DFI has been able to increase it by 6 fold in around 9 months by just cycling through steps 3 to 5.

On each position, you make a very very small profit. However, if you can build a very large position like UBank or Pak-Kuwait by repeatedly cycling through steps 3 to 5, the size of your profit may become meaningful.

FAQs

Question 1: In light of developments in the US banking sector wherein banks have been collapsing on account of mismatch between assets and liabilities, isn't this a risky position?

Answer: The US banks took positions in long-dated fixed-rate mortgage securities which can become illiquid or accrue valuation losses in a rising interest rate environment. The strategy we followed in Pakistan involves investing in securities which aren’t affected much in a rising interest rate environment. As interest rates rise (as had been the case for sometime now) you would get higher interest income on your investments because your long term investments carry a floating rate and you can roll over your maturing short term securities into the higher yielding newly issued short term T bills. Thus, unlike the US banks, there is hardly any valuation loss on your asset side and your interest income has actually increased. While on the liability and expense side, your borrowing costs are fixed. Thus, in a rising interest rate environment, this strategy produces a positive return, albeit a very small one.

Question 2: This is a huge increase in balance sheet size. This strategy would have resulted in earth shattering income.

Answer: Unfortunately, that does not appear to be the case. It is hard to tease out the net impact of this strategy for UBank from its financial statement. We can, however, calculate the return to Pak-Kuwait of this strategy. Pak-Kuwait’s total investment in government securities increased from Rs.64 billion to Rs.679 billion from Dec 31, 2021 to Dec 31, 2022. During the same period, Pak-Kuwait was able to increase its net markup income by mere Rs.272 million which translates into a return on average assets of 0.07%. But hey, it is risk-free easy money.

Editor’s note: Both UBank and Pak-Kuwait recently released their first quarter financials for 2023. Based on extensive interviews, a deep dive into both UBank’s and Pak-Ku- wait’s strategy and performance to follow in following issues of Profit.

Question 3: Is there a limit to this strategy?

Answer: To date we have not seen a ceiling. Pak-Kuwait successfully grew its assets 6 fold purely based on the aforementioned strategy in 9 months (total assets grew from Rs 137 billion at the end of March 2022 to Rs 798 billion on Dec 31, 2022). UBank doubled its asset size from Rs 104 billion on Dec 31, 2021 to Rs 221 billion on Dec 31, 2022 and its leverage (total assets/net assets) from 15x to 30X in the same period.

Question 4: Is this strategy followed by DFIs and NBFIs in other parts of the world?

Answer: Such strategies are usually part of relative value "long short" strategies adopted by hedge funds wherein they fund their extremely large position in treasuries through repos, while at the same time selling corresponding future contracts and profiting from small differences between yield on cash treasuries and the corresponding futures. Since the cash yield and futures yield move together, the hedge funds can pocket the small yield difference regardless of which way the market moves. Such strategies are affectionately referred to as "picking up pennies in front of a steamroller" as hedge funds have a tendency to blow up when such strategies don’t work as advertised.

In the case of UBank and Pak-Kuwait, there is no corresponding futures contract or short position to hedge their long position. Both are earning pennies based on the yield difference between their borrowing/repo yield and government securities yield.

Question 5: UBank maintains deposits of retail accounts. PakKuwait is using SBP repos which are usually short tenor (around 7 days or less). Isn't the SBP as a regulator worried about UBank and PakKuwait behaving like hedge funds?

Answer: SBP's mandate is the financial stability of the system. I cannot claim to understand what SBP is thinking other than what has already been explained in Question 1 above, however, I can assume that despite the fact that leverage of UBank has increased from 15x to 30x based purely on the above strategy, SBP does not deem it to be a systemic risk to the financial system. Pak-Kuwait does not have retail deposit accounts and all its borrowing is against “risk free” government securities which are pledged with SBP. Also Pak-Kuwait, for now, is using longer-term repos to borrow from SBP, that range from

63-70 days.

Question 6: Don't the auditors or the board of directors or board risk committees find this approach risky?

Answer: The auditors have not highlighted any risk from the aforementioned strategy in the annual accounts. If the board or the risk committee had any concerns, they have been allayed by the management. Otherwise how could UBank have increased its leverage to 30x in a year and Pak-Kuwait increased its asset size by 6 fold in 9 months. The board of directors and risk committees would be fully on board with this strategy.

Question 7: DFIs are allowed to participate in open market operations under SBP DMMD circular 11 of 2022 which allows DFIs to participate in OMOs for liquidity management. Pak-Kuwait is using OMOs to take highly leveraged and speculative positions in Government securities. This isn't the objective of the circular. Is SBP not aware of it?

Answer: SBP should be fully aware of it. Over the years, repo balances on the SBP balance sheet have been increasing and have become a permanent source of indirect financing, via commercial banks, to the Government of Pakistan. Since the late 2021 and throughout 2022, SBP conducted 63, 70 and 77 day OMOs, not necessarily to inject liquidity in the system, though that is the official line, but to provide cheaper source of money to commercial banks to nudge them to participate in the auction of government securities which otherwise the banks are reluctant to do so fearing rising interest rates. All this to say that SBP should be fully cognizant that participation by Pak-Kuwait in OMO isn't for liquidity reasons but to be a leverage buyer of government securities, similar to the commercial banks.

Question 8: Why do banks lend against pledged Money Market Fund (MMF) units?

Answer: The banks own the Asset Management Companies (AMC’s) that manage the MMFs. By lending against the MMF units, banks help their AMCs increase their Asset Under Management (AUM). This enables AMCs to earn higher income as AMCs charge management fees based on AUMs. From a risk perspective, the MMFs invest in government securities so banks are essentially lending against government securities thus taking minimal risk.

Question 9: For this to make sense for NBFIs and DFIs, banks should be lending at a slightly lower rate than the yield on government securities. Why are banks leaving money on the table and not investing directly in government securities?

Answer: In September 2021, the government decided to impose an incremental tax on banks whose advances-to-deposit ratio (ADR) would fall below particular benchmarks apparently to encourage the banks to lend to the private sector. However, the banks it seems found a way out of this conundrum i.e., window dress their investments by lending to NBFIs etc., which then purchase government securities with this money and pledge those securities to the same banks. The banks may be leaving a few bps (one bps is 1/100 of 1%) on the table but saving a few percentage points on the tax. It is funny how egregious some of the banks have been in this i.e., first lending/depositing money to/with the borrower to invest in MMFs, and then lending more money to the borrower against the very MMFs to buy government securities, and so on. In the bank and SBP reporting, this appears as advances/lending whereas effectively it is indirect investment in government securities.

Editor’s Note: Two big banks, namely UBL and ABL, were specifically asked to explain their intentions behind lending to NBFI’s and not investing directly in government securities. No response was received till the filing of this report.

Question 10: If a new corporate/ NBFI/DFI wants to take part in this strategy, which are the main institutions to approach?

Answer: For a DFI, doing repo with SBP is the easiest and most straightforward strategy using government securities as collateral. As of Dec 31, 2022, Pak-Kuwait had 97% of its government securities pledged as collateral.

For others (NBFIs/Corporates), we have seen banks accept Faysal Asset Management and ABL Asset Management MMFs as eligible collateral.

On the bilateral lending side and repos, UBL, ABL, MCB, Askari Bank and Bank of Punjab appear to be big players. There may be others, but we haven't been able to establish them. This is not to imply that all of the above mentioned banks were involved in window dressing. n

@2paisay is a citizen journalist who writes about the SBP, real estate, and other subjects. He prefers not to disclose his real identity, and thus writes and tweets under the pseudonym @2paisay.

Mariam Umar is a member of the staff.