June 02 - 08, 2008

Despite fiscal and debt limitation Act 2005 has prescribed to the government to scale down the revenue deficit to nil till the end of June 2008, there is rare chance in sight that government can even be able to adhere to the projected revenue deficit in the next fiscal year too. In effect, its astronomical receipts from central bank may unlikely be on short. The contention is drawn from the considerable revenue-expenditure shortfall (budget deficit) noticed in the first half of financial 2007-08 wherein budgetary deficit peaked to Rs. 356 billion given the fact that whole year target was set as Rs. 399 billion i.e. 4.0 % of GDP. This deficit is mostly offloaded on central bank's reserves owing to scheduled banks' lacklustre interest in government's securities. In spite of consent to graduating internal borrowing in the beginning of FY08 government's borrowing from central bank during July- May, 2008 hit Rs. 544.1 billion figure compared to the previous year's level of Rs. 35.9 billion. This has proved that the Government keeps treading on the line of defying its intention of minimizing dependence over State bank's reserves and outlawing the legislation that has jeopardised the fiscal management and nullified the effectiveness of the Act.

According to an estimate, the government may have resorted to central bank's reserves to abridge 80% of its current revenue deficit during the financial year of 2007-08. It was befitted a case of increasing government's liability in absence of proportional assets increase. Adopting neutral fiscal and debt management policy, the Act sought reducing the revenue deficit to nil not later than June 2008, thereafter maintaining of revenue surplus was to be occurred. While, this Act made its appearance in year 2005, the prescribed provisions ensured that within a period staring from July 2003 and ending on June 2013, the total public debt at the end of the tenth financial year should not exceed sixty per cent of the gross domestic product. In any given year, the total public debt should not be reduced less than two and half percent of the estimated gross domestic product.

Along with, the provision restricted the government not to slash budget allocation on poverty alleviation and public service development programmes down below 4.5% of the total GDP. Rather budgetary allocation for education and health sectors must be doubled. The former government had announced federal PSDP allocation of Rs. 335 billion for the year 2007-08. However, the financial constraints limited its actual spending on federal development programmes to Rs. 194 billion during July-March08. It would not be more than Rs. 275 billion by yearend.

In a normal condition, debt monetization remains an effective tool of generating revenue needed for the government expenditures but amid a prevailing situation when recurrence of debt instrumentality creates liquidity crisis the tool should haven't been the Hobson's choice. Compounded with strict monetary measures taken by the State bank, liquidity positions of banks are demanding crucial debt management innovativeness. The recent increase in discount rate by 150 basis points to 12% was induced by the central bank to mitigate the impact of excessive government's borrowing. For that matter, central bank offset the massive load of government borrowing by instigating uncalled participation of the scheduled banks in T-bills auctioning given the fact that this short term debt instrument for mobilizing revenue has been under performing in recent past. The rise in floating debt gained its share in GDP from 11.1 percent in June 2007 to 14.7 percent by April 2008.

For the time being, government may find a way out to contain its financial constraints, but in a long term the absolute reliance on debt monetization has serious repercussions for the inflationary graph, cost of factors of production, smooth scheduled and commercial banking operations, and importantly public at large. Inflationary pressure caused by the government borrowing translated into business unfriendly central bank's measures related to increase of discount rate basis points. Which automatically pressurises rate of lending (especially for running finance) that may apprehensively be stirred by 5% limit on return on deposit for banks. Lending rate increment clearly results into the high cost of working capital.

Besides, commercial banks are facing liquidity shortfalls owing to regular raise of cash level of banks deposited in the central bank. Worldwide such monetary measures are accepted unpleasantly by the business community. However, many countries have outrightly rejected governments steps to entitle debts as currency and disliked borrowing from central banks in a course to promote genuine monetary circulation as well as to subside inflationary aftermaths of debt monetization. GCC, which is a block of high per capita income countries, is also looking to restrict public debt to 3% of GDP. Typically, Saudi Arabia increased thrice bank reserve requirement within a shorter period of time. It is noteworthy to mention here that Saudi Arabia Riyal hooks with US dollar whereas taking a smarter move Kuwait has untied its dinar from dollar and hooked it to a basket of currencies in earlier 2007 in order to avert the affect of falling dollar on its currency.

Monetary tightening alongside structural changes to stabilize exchange rate may probably control the money supply, but stock of government borrowing from State bank, which multiplies the last year's level, may more likely to quash the effectuation of monetary policy. Therefore, it is a high time that government must follow the workable rules and principles laid in the Fiscal Responsibility and Debt Limitation Act, 2005 even if it is identified with few lacunas that require amended provisions to further entangle the debt monetization. While it is realized that government accosts to central bank because of lack of other revenue sources it should do this as a last resort. In addition, State bank's hastily resort to tighten monetary policy would likely to block the alternative techniques of resolution and motivate the reliance of government on transitory solution for coping with its financial constraints. Prudently government should ponder at the ultimate ramifications of debt monetization on economy and must scale down its stock of borrowing from the central bank.