Jan 3 - 9, 20

The government is heavily relying on domestic borrowing, which would not only fuel the already high inflation but also discourage growth besides squeezing the exchange rate.

The government borrowing from the State Bank of Pakistan (SBP) rose to Rs328 billion by mid December 2010 and is expected to go up to Rs600 billion if Rs2 billion daily borrowing from the central bank continues for the remaining period of the current fiscal year 2010-11. Analysts fear that the higher domestic borrowing is likely to increase the interest payments on domestic and foreign borrowing, from Rs699 billion allocated in the budget to over Rs720 billion, as the allocated amount of interest rate had been calculated on the basis of 5.1 per cent fiscal deficit.

The government relies on banking system for budgetary support in order to meet its financing needs. During the current fiscal year, the government borrowing from the central bank registered a massive increase of 346 per cent.

Analysts argue that a shortfall in revenue and rising current expenditure has compelled the federal government to borrow more from the central bank to meet its requirements.

The federal government borrowed Rs82.563 billion from scheduled banks in July-December 2010-11, which is Rs69.779 billion less, or 54 per cent, when compared with borrowing during the same period of last fiscal year, according to central bank. Net government sector borrowing from banking system surged by 50 per cent during the period. With current upsurge in net government sector borrowing for budgetary support mounted to Rs416.886 billion in December this year, as compared to Rs278.886 billion in same period of last fiscal year.

The government borrowed 280 billion rupees from July 1 to Nov 27, which is 29 per cent more than the same period last year. The inflation-fueling government borrowing has forced the central bank to raise its discount rate. The central bank on November 29 raised its benchmark discount rate for the third time since late July, by a half point to 14 per cent.

High interest rates have undermined economic growth. The growth is forecast by the government at 2.5 per cent in the current fiscal year, compared with a 9.1 per cent estimate for the current fiscal year in India. The IMF has forecast that the country's economy will grow 2.75 per cent in 2011, 4 per cent in 2012, and 5 percent in 2013.

Finance Ministry has asked parliament to enact legislation placing limits on borrowing. Under the legislation, the government will be required to limit borrowing from the central bank to 10 per cent of the previous year's revenue.

The government borrowings from the central bank have deteriorated the currency-to-deposit ratio of the banking system. During June 2003 and June 2007, currency in circulation grew by 70 per cent and total deposits of the banking system, excluding government deposits, grew by 104 per cent. In the following three years, currency in circulation increased by 82 per cent, while deposits increased by only 40 per cent.

The central bank has called the government's heavy reliance on banking system for financing need as the key risk factor in achieving the basic objective of the financial system in the country. The private sector has borne the brunt of required adjustment in the economy and the government has considerably crowded out the private sector both through reduced availability and price of credit. SBP Governor Shahid H Kardar recently termed heavy government borrowing as a major cause of whooping inflation.

The country's headline inflation ballooned to a 18-month high in November on the back of high food prices. Consumer Price Index (CPI) inflation rose to 15.48 per cent in November from 15.33 per cent in October indicating an upward trend in the price spiral showing impact of the flood on food prices. Analysts warn that the continued government borrowing from the central bank could accelerate the inflation further high.

SBP governor pointed out that in cumulative terms, country's economy has experienced an inflation of 66 per cent between June 2007 and Oct 2010, as against 36 per cent inflation seen during June 2003 and June 2007. He maintained that the monetary policy alone could not control inflation and stressed the need of a well coordinated strategy, which must include timely response to changing macroeconomic conditions along with concerted efforts to raise productive capacity of the economy.

Though the country announced last month a fiscal deficit of 4.7 per cent of GDP, agreed with the IMF for fiscal year 2010/11, yet the fiscal deficit for the first three months of the current fiscal year was 1.6 per cent of gross domestic product, compared with a fiscal deficit of 1.5 per cent in the same period last year. Analysts forecast a budget deficit of at least 6 per cent of GDP, as they believe that widening fiscal deficit in the first quarter warns that the country would likely overshoot the deficit target by the end of the fiscal year in June.

Failure to raise enough revenue has forced the country to cut its development spending by almost half to meet fiscal deficit target. The country will reportedly cut its Public Sector Development Programme (PSDP) budget by 46 per cent to 150 billion rupees ($1.75 billion) for the current fiscal year 2010-11.

"Pakistan is really stuck between two difficult choices, but first and foremost, the cut in PSDP is because there is pressure to meet a certain fiscal deficit target," Reuters reported Khalid Iqbal Siddiqui, Director at Invest and Finance Securities Ltd as saying.

The analysts predict that the new relations fostered with the IMF will now last longer, as the government would have to take recourse to large-scale borrowings in future. The country has to pay back nearly $3 billion to IMF alone from 2012.

Pakistan is still under the burden of $53.7 billion foreign debt while the payment of $6.03 billion had already been made during the last three years. The total loan comprises $44.8 billion of public and publicly guaranteed loans and $8.9 billion of IMF. The government paid $1.13 billion loan in 2007-08, $2.5 billion in 2008-09, and $2.3 billion in 2009-10 along with the interest worth $982.6 million, $872.9 million and $775.4 million, respectively.