Fiscal deficit in the outgoing financial year soared to 5.8 per cent of GDP from 4.6pc in the preceding year. The current account deficit, too, shot up to four per cent of GDP from only 1.7pc a year ago.

The worsening of the twin deficits has multiple implications for the economy in general and for fiscal and monetary policy coordination in particular.

The enlargement of fiscal deficit means a spike in government sector spending (in the 2016-17 fiscal year it was attributable chiefly to spike in provincial governments’ spending) in the absence of a matching increase in revenue collection. This leads to increased government sector borrowing from the central bank or from the banking system.

That is why the cumulative borrowing (for budgetary support) of the federal and provincial governments (from both the central bank as well as the banking system) rose to about Rs1.087 trillion in 2016-17 from Rs791bn a year ago, data released by the State Bank of Pakistan (SBP) shows.

In ordinary circumstances, increased borrowing for budgetary support should have crowded out the private sector but it did not happen in 2016-17 because the bulk of this borrowing (about Rs908bn) was obtained from the SBP and only a small part of it (Rs179bn) from the banking system.

Borrowing from the central bank essentially means printing of new currency notes and it is inflationary in nature. The reason why inflation actually remained in control despite such high government borrowing is low international oil and commodity prices and government-administered domestic prices of essential commodities.

Increased output of agriculture and manufacturing sectors also played a role in keeping inflation in check via increase in supplies. The agriculture sector grew 3.46pc in 2016-17 compared to a contraction of 0.2pc in 2015-16, whereas large-scale manufacturing recorded 5.6pc rise against 3.13pc a year ago.

Keeping the monetary policy stable in 2016-17 despite heavy government borrowing carried its own price tag: banking spread shrank to 2.51pc at end-June from 3.17pc a year earlier.

Most bankers say that less than three per cent spread is too low in Pakistan’s banking environment where the bulk of funds remain parked in government debt papers, that are risk-free but offer low returns, and where the cost of monitoring private sector credit quality is high.

Small wonder then that the banking spread rose to 2.81pc in July as average fresh deposit rate of all banks (excluding zero-rated and minus inter-bank deposit rates) fell to 4.6pc from 5pc in June, whereas their average fresh lending rate (excluding zero-rated and minus inter-bank lending rates) slid to 7.41pc from 7.51pc in June.

Clearly, depositors suffered. And, they suffered because it is easier for banks to cut deposit rates than to increase lending rates.

Considering the fact that headline inflation in July was 2.9pc, net average fresh deposit rate of banks comes to 1.7pc (4.6 minus 2.9). Inflation in August soared to 3.4pc which means if banks’ average fresh deposit rate remains at 4.6pc in August, too, then the net deposit rate would fall further to 1.2pc.

We will come to know about the exact net deposit rate sometime next month when interest rate data for August comes out.

Keeping net deposit rate at such low level has its own implications for banks’ deposit mobilisation and for the government’s and the central bank’s drive for the documentation of the economy. That is perhaps why bankers are anticipating tightening of monetary policy now.

The current account deficit ballooned in 2016-17 primarily because of a huge trade deficit. The trade deficit may not see a big decline in this fiscal year despite all efforts of boosting exports and containing imports of luxury items because machinery imports of 2016-17 (largely related to CPEC) will continue through next few years as work on CPEC gathers further momentum.

A big increase in foreign investment flows (mainly on account of CPEC) and improvement in exports (as a result of export-boosting measures) can, however, keep the current account deficit in check.

Although the business community itself is divided over whether rupee depreciation at this stage can help exporters, the mere fact that the rupee is overvalued calls for letting the rupee find its market value.

On July 5, the SBP’s move to let the rupee find its market worth was opposed vigorously by the government, and the central bank was rather forced to let the local currency rise again.

The central bank did it. But by the monetary policy revision towards the end of this month, it will allow some depreciation in the rupee value, more so, if it does not want to tighten the monetary policy in the upcoming review.

Or else, it may go straight for monetary tightening, buying some more time to rethink its forex policy, according to interbank forex and money market dealers.

But just like in case of the 3.2pc rupee depreciation on July 5, which was opposed by the Ministry of Finance primarily because it would have increased the cost of foreign debt servicing for the government, a monetary tightening at this stage can potentially increase the cost of its local debt servicing.

In the absence of monetary tightening now, low net deposit rates may continue.

Published in Dawn, The Business and Finance Weekly, September 11th, 2017