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Governments have to borrow when they earn less and spend more. And they borrow from both domestic and foreign sources.

But this is done under a policy framework with clearly spelled-out strategic guidelines.

In our case, we have a medium-term debt policy framework that is regularly updated. The current one covers the period between 2015-16 and 2018-19. At the end of this fiscal year in June, policymakers will evaluate as to what extent the federal government met the strategic guidelines provided in the debt framework and why slippages occurred.

In this write-up, we will focus on the targets the government is supposed to meet in terms of domestic debt mobilisation and management and see what challenges it faces in both areas.

One key target was to lengthen the maturity profile of domestic debt. This means that the PTI government has little room for mobilising short-term domestic debt during this fiscal, which is the final year of the four-year medium-term debt strategy. But this does not absolve it of the responsibility to pursue this target as vigorously as possible because a slippage in it will have implications for the economy.

A large fiscal deficit is likely to compel the government to continue financing a large part of it through domestic bank and non-bank borrowing

“So the government will have to attract enough investment in long-term Pakistan Investment Bonds (PIBs) while keeping its reliance on short-term treasury bills low,” explains the treasurer of a large domestic bank.

A high fiscal deficit last year, the new government’s push for increasing development expenses to avoid a sharper decline in economic growth and not-so-robust growth in revenues are the factors that will keep its short-term borrowing requirements high. This is a common theme of the debt market assessment reports of many local banks that they make for internal use.

“Now even short-term borrowing requirements can be met through mobilising banks’ investment in long-term debt instruments, but that creates tenure mismatch in domestic debt and leads to unnecessary add-ups in the cost of borrowing. So meeting short-term borrowing requirements via short-term treasury bills or other short-term instruments of non-bank borrowings is preferable,” says a well-placed source in the Ministry of Finance.

In 2017-18, servicing of domestic debt consumed Rs1.32 trillion, or 17.7 per cent of total expenses. It was higher than even defence expenditure of Rs1.03tr. Obviously, there is a need to keep the cost of domestic debt servicing in check and that is possible in large part through mobilising smaller amounts of fresh debt while opting for longer-term debts at the same time. Keeping in view the future build-up in the cost of domestic debt servicing and tenure mismatches in particular fiscal years with ultimate repercussions in future years, hitting the right mix of short-term and long-term domestic debts is difficult.

That is where the role of the government’s debt office and the Ministry of Finance and that of the central bank becomes crucial. Effective domestic debt management requires greater fiscal-monetary coordination.

The fiscal deficit for the current year can still remain large enough, compelling the government to continue financing a large part of it through domestic bank and non-bank borrowing. Up to Nov 2, the government has relied on excessive borrowing from the central bank ie printing of additional currency notes. That is why inflationary pressures persist in the economy. It did so to retire bank borrowings that had taken place earlier. Borrowings from banks will start pretty soon, but to a great extent that will offset the impact of the government’s borrowing from the central bank, central bankers say.

This means that the government will have to either increase its borrowings from non-bank sources chiefly through national savings schemes or resort to heavier borrowings from banks. Exercising the first option is not an issue because with treasury bills and bonds’ yields now higher than before, as a result of the interest rate tightening by the central bank, banks will love to invest in them. That is how the government borrows from banks. But increasing non-bank borrowings can be an issue, officials of the Ministry of Finance admit.

The reason is despite some increase in the rates of return, individuals and institutions seem less interested in continuing to invest in these schemes for a host of reasons, they admit. Better investment opportunities available in the stock market, particularly through mutual funds, a low level of services available at the National Saving Centres, lack of digitisation, a possible decline in individuals’ and companies’ incomes due to the prospects of lower-than-last-year’s GDP growth are some of the factors that can keep investments in these savings schemes low, they fear.

When the economy grew 5.8pc in 2017-18, fresh investment in savings schemes totalled Rs203 billion, a little less than Rs208bn in 2016-17. And even more than half of that investment (Rs104bn) came into prize bonds. Since most of the prize bonds are not registered and as such remain a source of parking of untaxed funds, no government can rely on them as a quality source of non-bank borrowing, officials of the Ministry of Finance say.

Perhaps the government needs to move decidedly towards launching new exclusively designed bonds for domestic market — for example, energy and water bonds. These bonds can be made available for investment for banks as well. To make them attractive, their yields can be linked with PIBs and money generated from their sales can be used to meet domestic financing part of foreign-funded development projects in energy and water sectors.

Banks cannot invest in national savings schemes as they compete with their own deposit schemes. New registered bonds can also be launched for upcoming agriculture and environmental development projects to reduce reliance on prize bonds.

Published in Dawn, The Business and Finance Weekly, November 19th, 2018