Research Analyst
Sep 13 - 26, 2010

Public debt has increased considerably over the past decades and this trend was generally accompanied by an expansion in the size of government's expenditures. For many industrial countries, the growth of government expenditures was enormous in the 20th century. Before it, the accumulation of government debt was in general slow and occurred mainly in relation to wars.

Currently, in Pakistan the federal government borrowings from the central bank was increased to Rs155 billion in seven weeks of this fiscal year 2010-11 from Rs21 billion. The bulk of this borrowing of Rs120 billion took place in three weeks of August amidst release of funds for rescuing and providing relief to flood-affected people. But, low revenue collection in July-August and expanding fiscal deficit due to ongoing war-on-terror and transfer of more resources to the provinces from the divisible pool also pushed up the borrowing. The least-controlled day-to-day government spending was also responsible for a dramatic rise in federal government borrowings from the SBP.


M2 448.1 9.6
SBP -155.8 -32.4
Scheduled banks 5.6 3.0
SBP 106.9 13.8
Scheduled banks 491.4 15.1
Government borrowings 524.0 34.7
For budgetary support 316.4 23.2
SBP 130.9 12.7
Scheduled banks 185.5 56.1
Non-government sector 171.9 5.7
Credit to private sector 18.9 0.7

Between July and August, 2010 the federal government retired Rs45 billion commercial bank loans against Rs49 billion borrowing during the same period last year. Massive government borrowing from SBP combined with a substantial rise in currency in circulation (CiC) may add to the inflationary pressures created by food supply shortages after the floods. CiC grew by Rs79 billion up to August 20 this year faster than in the comparable period of last year when it had expanded by Rs52 billion. And, much of the expansion (Rs58 billion) took place in three weeks of August. Bankers attribute CiC acceleration to pre-Eid, Ramazan-related deposit withdrawals reinforced by withdrawals from bank accounts by businesses, NGOs, and individuals for providing relief to flood-hit people.

However, the larger government borrowing would possibly add to inflationary pressures. But, it is growth in reserve money (and not just increase in government borrowing or aggregate increase in broad money or M2) which affects inflation.

Up to August, reserve money expanded by four whereas M2 grew just two per cent. That indicates inflationary pressures would remain strong in coming months. Year-on-year inflation gauged by Sensitive Price Indicator (SPI) was stood at 14.6 per cent during the last pre-flood week ending on July. Thereafter, SPI inflation kept on rising and closed at 16.7 per cent during the week ending on August.

The strategy to borrow from the SBP and retire commercial bank credit has so far helped them keep the cost of domestic debt in check. Foreseeing some pressures on the fiscal side, banks are trying to lend money at unacceptably high rates. Once sufficient funds start flowing in from international community as well as from the IMF and the World Bank, banks would realise the fiscal position is not that vulnerable and they would be willing to lend at reasonable rates.

Although the government borrowing from the SBP is not zero-rated but it remains lower than that of their commercial borrowings. During the week ending on September, exchange and interest rates remained stable. Exchange rates remained stable primarily due to huge inflows of remittances also because of the continuing SBP support to the local currency through dollar/rupee swaps and relaxation in foreign exchange exposure of banks. And, interest rates maintained stability as the central bank continued injecting cash into liquidity-starved inter-bank market.

IMF's flood emergency loan of 450 million dollar within this month combined with continued inflows of foreign aid may ward off the pressure on rupee due to end-quarter external debt servicing. Pakistan had received $92.84 million cash grants from around the world till August out of $889.73 million overall financial pledges in cash or kind (including $657.4 million grants).

Despite an anticipated spike in post-flood inflation, the SBP may keep its policy rate unchanged in its next monetary policy due by month-end to avoid dampening economic growth already threatened by the floods. And as such interest rates may also remain stable. On July 2010, the SBP had raised the policy rate by 50 basis points to 13 per cent.

Moreover, government borrowings for budgetary support from the banking system in FY09 was considerably low following significant decline in fiscal deficit and improved non-bank financing inflows, especially from national savings. As a result, net budgetary borrowing from the banking system was increased by Rs316.4 billion during FY09 compared with Rs554.6 billion in FY08. The banks borrowing constituted nearly half of total budgetary financing in FY09.


Whatever may be the advantages of government borrowings for economic management in this system, the experience shows that it may have economic disadvantages as well.