The Future of State-Owned Financial Institutions

11. Lessons from Pakistan

 Lessons from Pakistan 11 P’   privatization, which began in the early 1990s and continues today, offers valuable lessons for policymakers in other emerging economies. Pakistan successfully reduced state ownership in the banking sector from 92 percent of assets in 1990 to 18.6 percent in 2004. The government also pushed through a number of very tough policies dealing with overstaffing, overbranching, and nonperforming loans and managed to attract top managers from international banks to bring an infusion of new skills to the sector. This chapter lays out the hurdles Pakistan faced and the measures taken to privatize the banking system. Nationalization of Pakistan’s Financial Sector In 1974, when the world was being swept by socialism, the Pakistani government decided that the best way to achieve economic development and equitable growth was to nationalize everything: industries, banks, insurance companies, educational institutions, and so forth. Policymakers embraced socialization because they perceived that there was a strong concentration of wealth. But nationalization resulted in a huge economic setback for Pakistan, compared to growth levels under its previous , market-driven, policies. In 1969, for example, exports were higher than the combined exports of Indonesia, Thailand, Philippines, and Malaysia; these were drastically reduced by the nationalization efforts of the 1970s.   11-1335-5-CH 11 12/9/04 3:38 PM Page 259 By the 1980s the banking sector was dominated by public institutions. The government exerted direct monetary control, controlled credit, directed credit, and determined pricing for financial institutions. Most of the borrowing was done by the government for fiscal deficit financing or meeting the losses of public sector corporations. The relationship between government and the financial sector was incestuous, which led to financial repression, financial sector inefficiency , crowding out of the private sector, and deterioration of asset quality. Further , the central bank could not effectively play any role in the growth of financial institutions or in cleaning up the mess because the Pakistan Banking Council had clipped its wings: The central bank was now directly controlled by the government of Pakistan. By 1990, 92 percent of the assets, 93 percent of deposits, and 86 percent of the equity in Pakistan’s financial sector was in the hands of state-owned financial institutions (table 11-1). There were no private sector banks (except some foreign banks, which played a marginal role because of the restrictions and directed credit controls in place). Pakistan’s banks were characterized by high intermediation costs, overstaffing, overbranching, a huge portfolio of nonperforming loans, poor customer service, undercapitalization, and a poorly managed and very narrow product range. The banks’ primary business was to serve government organizations, subsidize the fiscal deficit, serve a few large corporations, and engage in trade financing. There was no lending to small- and medium-size enterprises, to the housing sector, or to the agricultural sector, which create most of the growth and employment in Pakistan. Most important, the financial system suffered from political interference in lending decisions and also in the appointment of managers.   Table 11-1. Preprivatization Structure of the Banking Sector, Pakistan, 1990 Assets Deposits Equity Amount Amount Amount (billions Share (billions Share (billions Share Type of bank Number of rupees) (percent) of rupees) (percent) of rupees) (percent) State owned 7 392.3 92.2 329.7 93.0 14.9 85.6 Private . . . . . . . . . . . . . . . . . . . . . Foreign 17 33.4 7.8 24.9 7.0 2.5 14.4 Total 24 425.7 100.0 354.6 100.0 17.4 100.0 Source: State Bank of Pakistan, “Financial Sector Assessment, 1990–2000.” 11-1335-5-CH 11 12/9/04 3:38 PM Page 260 Rationale for Financial Sector Privatization In the early 1990s the government introduced policies to liberalize the economy. At the same time, the World Bank was reporting on financial sector weaknesses in Pakistan and urging liberalization. Pakistan welcomed the Bank’s advice and accepted the suggested reform package. At first the government focused on lowering the fiscal deficit, state-owned enterprises representing the greatest burden. These enterprises’ efficiency levels were low, and their production seemed unresponsive to market demand. They were producing goods and services that nobody wanted, and the cost of their continuing losses was being borne completely by the government. To stem the losses and begin the privatization process, the government established the Privatization Commission in 1991. Its mission was to foster competition and to ensure greater capital investment, competitiveness, and modernization , thereby enhancing employment...