IN a big shift from past trend, the federal government has set quite a modest target for bank borrowing in FY15. This means banks will not be able to make the bulk of their interest income by investing in government debt papers, and will have to maximise lending to the private sector.

The budget papers show that the government will arrange just Rs228 billion through bank borrowing to fill in the fiscal gap.

In FY14 too, the government borrowed less from banks than the budgetary projection. This, in turn, compelled banks to lend more to the private sector. In a little less than 11 months of FY14, banks’ net lending to the private sector shot up to Rs325 billion, seven times more than their year-ago lending of Rs45 billion.

“Despite an uptick in demand, this would not have been possible had we not reduced our own bank borrowing,” Finance Minister Ishaq Dar said during a post-budget interview with a local TV channel.

By fixing a modest borrowing target for FY15, after actually resorting to lower-than targeted borrowing in FY14, the government has sent a clear signal to banks that it is serious about diversifying the sources of budgetary gap fillings

The federal government expects to keep its FY14 bank borrowing at Rs376 billion, far less than the originally budgeted Rs975 billion, revised budgetary estimates for the last fiscal year reveal. Finance ministry officials say even if actual bank borrowing till June exceeds the revised estimate, the deviation would not be significant.

Between July 1, 2013 and May 23, 2014, the federal government’s net bank borrowing stood at Rs276 billion, leaving room for another Rs100 billion in borrowing between May 24 and June 30. “So, rest assured, our projection won’t end up off the mark,” says a senior official of the ministry of finance.

The lower-than-targeted bank borrowing in FY14 was facilitated by larger-than-initially-planned income, mainly from capital and external sector receipts. And the government’s debt managers scheduled their borrowings from the SBP and commercial banks so that by the end of the year, they were able to retire the central bank’s debt — as required under the fiscal prudence law.

Up to May 23, the federal government’s borrowing from commercial banks stood at Rs339 billion, while it’s borrowing from the SBP became negative by Rs63 billion. As such, overall bank borrowing came to Rs276 billion. “But as the government cleared around Rs500 billion worth of circular debt of the power sector — mainly through debt papers — in effect, banks’ holding of debt papers was not much affected,” points out a senior local banker.

By fixing a modest borrowing target for FY15, after actually resorting to lower-than-targeted borrowing in FY14, the government has sent a clear signal to banks that it is serious about diversifying the sources of budgetary gap fillings. Trading of debt papers through the stock market has begun; Eurobonds have been launched; floating of a Sukuk in the international market is well under way; the privatisation plan is being pursued; and the National Savings Schemes are doing well.

And now, the capital gain tax has been imposed on government debt instruments, which would mainly hit banks, for they hold the bulk of these instruments. On the other hand, the target for agricultural lending by banks has been increased from Rs380 billion in FY14 to Rs500 billion in FY15.

“If you join the dots, you can picture what the government expects banks to do. They expect us to lend to the private sector and make our lending more inclusive by focusing on agriculture,” says a former head of the National Bank of Pakistan.

Bankers seem to be divided over whether the government will be able to stick to its low bank borrowing target of Rs228 billion or exceed it, if other projections of resource earnings slip by. But a majority of them believe that even in case actual bank borrowing exceeds the target, it would not be much helpful for banks from a profit-making point of view.

“The reason is we don’t think the borrowing will be higher by a very wide margin, though there is a chance for us to invest in T-bills and Pakistan Investment Bonds (PIBs), which the government may again use to clear the power sector’s circular debt,” says the treasurer of a large local bank.

Some bankers say they suspect a greater element of surprise in auctions of T-bills and PIBs, by which they mean that the government may borrow excessively at one auction only to retire part of this debt in the next one.

From the government’s point of view, this is good because it helps it keep the yields on debt instruments at the desired levels. But it is bad for banks. In an uncertain environment, some banks — particularly those awash with liquidity — tend to bid lower (i.e. they are ready to accept low returns on debt papers), whereas others may bid high. The government then accepts low-priced bids, shaking banks’ dependence on debt papers as a sure way of profit-making.

“That’s when we have to seriously look for more reliable streams of income, including higher and more penetrating lending to the private sector,” opines the treasurer of one of the top five commercial banks.

Published in Dawn, June 9th, 2014