An Anatomy of Credit Booms in Pakistan: Evidence from Macro Aggregates and Firm Level Data

Transcription

1. SBP Working Paper Series No . 101 December, 2018 An Anatomy of Credit Booms in Pakistan: Evidence from Macro Aggregates and Firm Level Data Muhammad Ejaz Muhammad Nadim Hanif STATE BANK OF PAKISTAN
2. SBP Working Paper Series Editor : Sajawal Khan The objective of the SBP Working Paper Series is to stimulate and generate discussions on different aspects of macroeconomic issues among the staff members of the State Bank of Pakistan. Papers published in this series are subject to intense internal review process. The views expressed in these papers are those of the author(s) not State Bank of Pakistan. © State Bank of Pakistan. Price per Working Paper (print form) Pakistan: Rs 50 (inclusive of postage) Foreign: US$ 20 (inclusive of postage) Purchase orders, accompanied with cheques/drafts drawn in favor of State Bank of Pakistan, should be sent to: Chief Spokesperson, External Relations Department, State Bank of Pakistan, I.I. Chundrigar Road, P.O. Box No. 4456, Karachi 74000. Pakistan. Soft copy is downloadable for free from SBP website: http://www.sbp.org.pk For all other correspondence: Postal: Editor, SBP Working Paper Series, Research Department, State Bank of Pakistan, I.I. Chundrigar Road, P.O. Box No. 4456, Karachi 74000. Pakistan. Email: wps@sbp.org.pk ISSN 1997-3802 (Print) ISSN 1997-3810 (Online) Published by State Bank of Pakistan, Karachi, Pakistan. Printed at the SBP BSC (Bank) – Printing Press, Karachi, Pakistan
3. An Anatomy of Credit Booms in Pakistan : Evidence from Macro Aggregates and Firm Level Data Muhammad Ejaz 1 & Muhammad Nadim Hanif 2 Abstract We identify private credit booms in Pakistan, using fully modified HP filter, and analyze the behavior of selected macroeconomic aggregates around these booms based on annual data over the period 19602018. We observe that credit booms are associated with economic expansions, increasing asset prices, appreciating REER and widening of current account deficit in Pakistan. Micro data analysis shows an association between credit booms and measures of corporate leverage, valuations and profitability. Our analysis of bank level data shows similar cyclical patterns in lending activity and profitability in banking system. Lastly, we find that credit booms in Pakistan are associated with sudden stops and currency crises but not with banking crisis. These results are in line with existing evidence on credit cycles’ dynamics in emerging markets. JEL Classification: E32, E51, G28 Key Words: Credit Booms, Business Cycles, Macroprudential Supervision Acknowledgments Authors would like to thank the anonymous reviewer for the valuable comments on this paper. Contact for correspondence: Muhammad Ejaz Deputy Director, Research Department State Bank of Pakistan I.I. Chundrigar Road Karachi 74000. Email: mohammad.ejaz@sbp.org.pk 1 2 Deputy Director, Research Department, State Bank of Pakistan, Karachi (mohammad.ejaz@sbp.org.pk) Lead Economist, Research Department, State Bank of Pakistan, Karachi (nadeem.hanif@sbp.org.pk) -1-
4. Non-technical Summary Private sector credit is considered as one of the sources of economic growth in developed as well as developing economies . However, excessive credit expansion raises concern being an indicator of peak of economic growth cycle followed by a deceleration phase. Credit expansion beyond country specific ‘threshold’ can trigger and amplify financial sector woes eventually leading to decelerating economic activities. Accordingly, policy makers all over the world, as well as in Pakistan, have established legitimate interest in monitoring the credit demand growth to keep credit supply in check. This has led to the development and use of tools for identifying and taming the credit booms to safeguard the banking system, and the economy, against any potential loses. In this study, we identify private credit booms in Pakistan and investigate the behavior of selected macroeconomic aggregates and firm level financial as well as non-financial indicators around these booms. We use annual data over the period 1960-2018. We apply ‘threshold’ method to identify the credit booms in the country. This method entails decomposing the real private credit series into cyclical and trend components and identifying episode(s) in which credit exceeds its long-run trend (by using a threshold level generally used in the literature) over the business cycle. We identify two episodes of credit booms for Pakistan: one in 1972-73 and other in 2007-08. At macro level we observe that credit booms in Pakistan are linked with increased economic activities, higher asset prices and deterioration in current account balances. We also find that credit booms in Pakistan are associated with sudden stops and currency crises. However, we could not find any association between credit booms and banking crisis in Pakistan − which we attribute to proactive banking supervision by the State Bank of Pakistan. Micro data analysis of listed non-financial firms shows an association between credit booms and measures of corporate sector leverage, valuation and profitability. Lastly, analysis of bank level data shows similar cyclical patterns in profitability of banks in the country. Most of the findings in this study are in line with existing evidence on credit cycles’ dynamics in emerging markets and with the scant observations reported in the relevant literature on Pakistan’s economy. -2-
5. 1. Introduction It is documented in literature that credit booms, manifested by excessive growth in credit, are harbinger of financial crises (Eichengreen and Arteta, 2002). The excessive growth in assets prices fueled by availability of easy credit has been a major factor that led to Global Financial Crisis (GFC) in 2007-081. Thus, rapid expansion in credit (beyond normal business cycles) can trigger and amplify financial crisis eventually leading to economic meltdown. The GFC of 2007-08 triggered by failure of financial giant Lehman Brother and resulted in turmoil in financial markets of the US, which affected both developed and developing economies. Pakistan was not an exception (Chart 1 in Appendix-C). Accordingly, policy makers in Pakistan as well as in other countries have always had an interest in monitoring the credit markets to keep the excessive growth in credit supply in check. Regulators and policy makers have constructed surveillance tools for effectively identifying buildup of abnormal credit cycles to safeguard the banking system against potential losses (Mendoza and Terrones, 2008). For example, a set of reforms mainly targeting bank capital (Basel-III) was a major step in this direction. The underlying philosophy of counter cyclical capital buffers is to protect banking system against possible future losses. Thus, these reforms, coupled with additional measures make financial system safer. In existing literature, researchers have studied credit cycles mostly in the context of developed world. However, a few, like Mendoza and Terrones (2008) and Arena et al. (2015) have also investigated emerging economies’ credit booms and their association with macroeconomic dynamics besides developed economies. Such studies in the literature on credit booms used a threshold method to identify the credit cycles. This method entails splitting the underlying variable into cyclical and trend components and identifying an episode in which variable of interest exceeds its long-run trend by more than a threshold2. Using the threshold method, these studies found that credit booms/busts are associated with economic expansion/contractions, deteriorating/improving external balances, rising/falling asset prices at macro level; and procyclical movements in firms level indicators (like share of external financing) and bank level indicators (like non-performing loans). As most studies explain underlying dynamics on aggregate basis for both emerging and developed economies which hides the country specific dynamics. Thus, there is a need for studying the credit booms and their relationship with major macroeconomic, firm and bank level indicators along with macro-prudential supervision measures for informed policy making in a developing country like Pakistan. A main feature of threshold method in studying booms is that it entails separating trend from cyclical fluctuations. Most studies in the literature have used conventional HP filter to identify the underlying trend. HP filter is not without limitations. Two major issues stand out. First, this technique uses an arbitrary value of smoothing parameter