Despite rising interest rates, the federal government is borrowing lots of money from commercial banks to bridge the gap between its income and expenses. And banks are happy. They are earning windfalls by investing in zero-risk government treasury bills and bonds.
But the private sector is suffering as most banks cater to only large industrial/ commercial borrowers besides offering consumer loans. Net lending to agriculture and small and medium enterprises remains low. All this is happening because the government has not been able to cut current expenses. And its tax revenues remain below potential.
That said, tax revenue collection has been on the rise for the past few years. Its lower-than-targeted growth during this fiscal year can be explained in large part by the fact that the post-flood economy is sinking. But that does not mean that structural issues in the tax collection system have gone away. Quite the contrary. They have instead become more entrenched.
In more than four-and-a-half months of this fiscal year (between July 1 and November 18, 2022), the federal government borrowed Rs1.238 trillion from banks. On the other hand, banks’ lending to the private sector during this period totalled just Rs42.6 billion, according to the latest data from the State Bank of Pakistan (SBP).
If credit demand remains unmet, firms use up retained earnings in their day-to-day operations instead of channelling them into long-term growth projects
The bulk of the government’s current expenses goes towards domestic and foreign debt servicing and defence. So, that cannot be expected to shrink anytime soon, and the government’s bank borrowings from banks may rise further during the remainder of the fiscal year. In the last fiscal year, the government had ended up using Rs1.129tr bank credit, exceeding the originally planned borrowing of Rs681bn, budget documents show.
For this fiscal year, the initial estimate of the use of bank credit for fiscal balancing is just Rs93.2bn. Actual borrowing may rise many times over.
Year after year, governments in Pakistan borrow heavily from banks. On the one hand, this practice adds to the stock of domestic debt, and on the other hand, it keeps banks’ private sector lending low.
The growing domestic debt stock compels the government to allocate more and more funds for interest payments. That, in turn, results in the minimum allocation of resources for development and often necessitates frequent cuts in annual development plans.
Between July 1 and November 18, the federal government borrowed Rs1.238tr, whereas banks’ lending to the private sector totalled just Rs42.6bn
Scant lending to the private sector impedes the growth of private sector businesses, which results in lower than the potential contribution of the private sector towards economic growth. Cuts in the government’s annual development plans and lesser contribution of the private sector to economic growth, together, keep average yearly GDP growth low — and joblessness high.
This structural problem can be effectively addressed if (1) the government increases its tax and non-tax revenue and (2) slashes the cost of running the government, and (3) ensures that government spending contributes more to economic growth.
Tax revenues have been growing for the past several years, but non-tax revenues have not. Besides, the much-needed shift from indirect to direct taxes has not occurred. And, for many years, government spending in Pakistan has not made any meaningful contribution towards economic growth.
This is primarily because current spending is largely least-productive in nature, and development spending is not well-aligned with the ever-changing requirements of economic growth. For example, small and medium enterprises (SMEs), agriculture and IT and IT-enabled services sectors have received much less development funds than the big ticket, politically-beneficial roads and public transport projects.
The simplest way of analysing the quality of government spending could be to find out whether it has reduced joblessness and raised aggregate output. The rate of joblessness in Pakistan (as a percentage of the labour force) has risen from as low as 1.8 per cent in 2012 to 4.4pc in 2021, according to the World Bank. And during the past 10 years, GDP growth has hit 6pc — the minimum level required for effectively reducing joblessness — only twice, 6.2pc in FY18 and 6pc in FY22.
For over a decade, Pakistan’s private sector borrowings from banks (as a percentage of GDP) have declined. In 2008, the private sector borrowing equalled 28.7pc of GDP, but this percentage gradually fell to 15pc in 2020, according to the World Bank.
Interestingly during these years, government borrowings from banks remained too high. So, it is fair to say that government borrowings have consistently been crowding out the private sector. More recent stats sourced from SBP proves this point.
In FY21, the federal government borrowed Rs2.959tr from banks, whereas the private sector’s borrowings totalled only Rs766bn. Even in FY22, when the private sector borrowings from banks hit an all-time high of Rs1.612tr (thanks largely to the post-Covid concessional loans), the government borrowings from banks were more than double this amount — Rs3.448tr, to be specific. According to the revised budget document, part of this amount, Rs1.129tr, was used to fill in the gap between budgetary income and expenses.
If the private sector’s borrowings continue to fall as a percentage of GDP for an extended period, banks are not meeting the credit demand of the private sector. And when credit demand of the private sector remains unmet for a long-time, firms use up their retained earnings in their day-to-day operations instead of channelling them into long-term growth projects like research and development, innovation and capacity building etc.
Besides, persistent fall in private sector credit makes credit-starved sectoral borrowers (like those in SMEs and agriculture) increasingly dependent on private moneylenders. This contributes to the enlargement of the shadow economy — particularly if the political will to document the economy remains weak and if the efforts made for the documentation avoid powerful segments of the society and focus on the weaker ones. That is exactly what has happened to the so-called documentation drives launched by successive governments during past two decades.
Published in Dawn, The Business and Finance Weekly, December 5th, 2022