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Rising cost of domestic borrowing

Updated March 25, 2019

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New borrowing will be pricier as interest rates are higher than a year ago.— AFP/File
New borrowing will be pricier as interest rates are higher than a year ago.— AFP/File

Internal political confrontation is growing and external threats to the national security persist despite an apparent de-escalation in the Pakistan-India conflict. Both factors are sure to affect the economy in many ways in the short-to-medium term.

At the time of a political transition, people hear promises of revolutionary changes in economic management like we did during the July 2018 elections. But after a while, it dawns upon the new political leadership that there’s limited room for fulfilling those promises. New leaders face limitations of all kinds — political, geopolitical, purely economic or security related — and they have to make compromises and trade-offs. That’s exactly what the PTI is doing these days.

Whether it is continuing with the old practice of allocating development funds to party MNAs and MPAs, requesting provinces to contribute three per cent of their NFC awards towards a Rs100-billion fund for tribal areas, returning to the International Monetary Fund (IMF) for a bailout, or borrowing from friendly countries to maintain foreign exchange reserves, the PTI is making compromises and trade-offs in all these instances.

New borrowing will be pricier as interest rates are higher than a year ago

“Pakistan’s macroeconomic challenges are not cyclical insofar as they are not caused by the business cycle, or a domestic or an external shock,” notes a recently released World Bank report.

“Pakistan’s macroeconomic challenges are structural: a revenue system that is unable to meet the government’s financing needs and consumption-led growth that relies on external flows for its sustainability and is therefore very vulnerable to changes in (such) flows,” adds the report titled, Pakistan@100: Shaping the Future.

“Failure to address these structural medium-term challenges, while stabilising the macroeconomic imbalances, just means that the next crisis is another four to five years away. The proverbial can is constantly being kicked down the Pakistani road.”

Our core economic issue is that we are short of both foreign and domestic financial resources. The tax base is shallow and domestic savings and investments are low. Stocks of foreign debt are growing, the central bank’s foreign exchange reserves at $8.84bn are barely enough to finance two months of imports — and that, too, after the injection of no less than $8bn from China, Saudi Arabia and the United Arab Emirates during the eight months of the PTI government.

The federal government’s domestic borrowing is also increasing with consequences for the economy and the banking system.

Since interest rates have been higher than last year’s after monetary tightening additional borrowings will definitely be pricier and add further to the cost of domestic debt servicing

In a little over eight months of the current fiscal year (July 1, 2018 — March 8, 2019), the federal government’s borrowings from the central bank have more than tripled to Rs3.39 trillion from about Rs1.08tr in the year-ago period. No wonder inflation is galloping. It’s true that the government has used a large part of it to retire commercial banks’ credit, but that does not indicate that the government is going to keep its commercial banks’ borrowing negative or very low at the end of the fiscal year.

It only indicates that so far the government has desisted from crowding out the private sector. But once it begins stopping printing new currency notes or starts retiring the central bank’s borrowing, which it will have to after finalising a balance-of-payments loan from the IMF, it will do this with the help of commercial banks’ borrowing. Between July 1 and March 8 of this fiscal year, the government has retired Rs2.15tr worth of commercial banks’ credit.

In the first seven months of 2018-19, the federal government has also made a net borrowing of Rs84bn through prize bonds and another Rs113bn from all other National Savings Schemes.

In the remaining five months, the government’s borrowing through prize bonds and other instruments of NSS will surely increase further. Whether higher interest rates on NSS will help the government attract sizable investment — more than via prize bonds — is yet to be seen. Since the beginning of this fiscal year, the government has increased the rates of return by 4.8 percentage points on three-year Special Saving Certificates and by 4.37 percentage points on five-year Regular Income Certificates and 10-year Defence Saving Certificates. On 10-year Pensioner Benefit Accounts, meant exclusively for senior citizens and widows, the rate of return has gone up by 4.2 percentage points.

Fixing fiscal gaps with domestically borrowed money means the government keeps adding to the stock of such borrowing with domestic debt servicing, claiming more on fiscal resources year after year.

In the first half of this fiscal year, domestic debt servicing cost the national exchequer Rs752bn. Add to this Rs479bn spent on defence affairs and services and you get a staggering total of Rs1.23tr. Small wonder then that total development expenses remained at Rs361bn — less than half of domestic debt servicing and 75pc of defence expenses.

In the current geopolitical environment, one cannot expect our defence expenses to go down, or even remain where they are. And given the fact that tax revenue generation remains short of target, it’d be naïve to think that the government’s domestic borrowing would fall either.

According to a Dawn report, the Federal Board of Revenue (FBR) missed the tax collection target by a huge Rs235bn in the first eight months of this fiscal year. Finance Minister Asad Umar says the government is now close to signing a balance-of-payment support deal with the IMF. With three months left of this fiscal year, we won’t have to wait for long to see where the fiscal deficit finally settles — the government admits it cannot keep it at the targeted level of 5.1pc of GDP and independent economists warn it could hit 7pc.

So, for the time being, domestic borrowing of the government will likely keep growing. Since interest rates have been higher than last year’s after monetary tightening — and further tightening is possible in view of headline inflation galloping at 8pc — additional borrowings will definitely be pricier and add further to the cost of domestic debt servicing.

Monthly average yields of three-year, five-year and 10-year government bonds shot up to 11.9pc, 12.58pc and 13.35pc, respectively, in February from 8.07pc, 8.54pc and 9.02pc in June 2018. Cut-off yields of three-month and six-month treasury bills also surged to 10.55pc and 10.6pc, respectively, from 6.76pc and 6.85pc, according to data reported by the central bank.

Published in Dawn, The Business and Finance Weekly, March 25th, 2019