INFLATION MIGHT BE SOARING

KANWAL SALEEM
(feedback@pgeconomist.com)

July 16 - 22, 20
12

Over the years, total government borrowing from the central bank has touched Rs2.6 trillion - a figure higher than the total size of the revised federal budget.

The government is desperately generating liquidity from all possible sources, whether from banking system or increasing taxes on petroleum products and natural gas.

According to sources, borrowing for budgetary support in less than nine months of the fiscal year 2011-12 rose to Rs1 trillion, much higher than the borrowing worth Rs374 billion made during the same period of previous year. The ailing economy is unable to generate revenue while government's spending is not under control.

The negative impact of massive borrowing from commercial banks and State Bank is visible in the face of increasing inflation. Along with core inflation, the main inflation (CPI) is also on rise.

The trend indicates that the main inflation might see more increase as government borrowing from Central Bank is on rise constantly.

High rate of joblessness, poor investment, no foreign investment and law and order situation are enough to cut size the economy and economic efforts of both the government as well as private sector. Some analysts see the economy in deep trouble as they identified a number of factors that are not favourable for growth. They said foreign factors are more important and are casting negative impact.

The country's leading businessmen warned the government against over-borrowing from the banking system, saying such dependence will create a liquidity crunch and thwart private investment.

Traditionally, a government confined its role to the creation of a regulatory framework in which the capital market, and in particular the banks, could play their intermediary role between the private sector savers and borrowers, without the government's participation in the process of saving and borrowing through that system. The reason was that a government was supposed to finance its expenditure with tax revenue, and did not indulge in large-scale borrowing as a means of financing its operations on a regular basis. In more recent times, governments, like individuals, have begun to rely heavily on borrowing. This practice is alarming for the economy, expert told PAGE.

He said domestic government borrowing can take one of the four forms. First, government can launch various small saving schemes to directly attract private sector savings as a means to finance government operations without the involvement of any financial intermediary. Second, a government can float debt instruments in the nonbanking section of the capital market to raise financial resources from individuals, institutional savers, partnerships and corporations. Third, a government can sell its debt instruments to commercial banks. Fourth, a government can place treasury bills with the central bank and on the basis of such an asset, the central bank gives an overdraft facility to the government making it possible for it to create new "high powered money" to finance its expenditure.

If done in moderate amounts, and with the right instruments, government borrowing can even help mobilise additional private sector saving. If done excessively, and with the wrong instruments, government borrowing can lead to financial disintermediation. This is what is happening in Pakistan at present, they added.

Recently, the scale of domestic government borrowing has increased sharply leading to serious implications for inflation, debt servicing, balance of payment and financial intermediation.

When the government competes with the private sector for borrowing from the market directly, and indulges in heaving borrowing, it leaves fewer saving that could be placed with commercial banks. The private sector mostly borrows for trade and investment, which helps promote economic growth. The government borrowing is at least partly for consumption and a large chunk of it is wasted or pilfered and therefore does not compensate for loss of investment in the private sector.

The interests of the banking system and of the economy will be served well if the government was to manage its fiscal affairs without large-scale borrowing from the market, commercial banks and the SBP. It will help mobilise savings and finance productive private sector investment and thereby promote financial intermediation and reduce the risks of financial instability.

Nevertheless, the government borrowing has been compounding the problem of inflation and consequently having serious impact on private sector. Unrestricted borrowing of the government complicated liquidity management; dilute the impact of monetary policy stance and puts pressure on exchange rate.

In March 2012 the yearly consumer price index (CPI) inflation was 10.8 percent and, given the current economic conditions, is projected to remain in double digits during FY13. Consistently growing government borrowing requirement from the banking system is a key variable that is adversely affecting the inflation outlook. Weak private demand, on the other hand, is one reason why inflation is not increasing sharply. Nonetheless, the size of fiscal borrowings and lack of investment is eroding the medium-term productive capacity of the economy, contributing towards persistence of inflation in early double digits.