KARACHI, Feb 8: The government borrowed Rs42.8 billion from the banking system in less than seven months of this fiscal year, i.e. between July 1, 2004-January 22, 2005, according to data released by the State Bank.

This much borrowing for budgetary support is within the revised target of Rs60 billion for this entire fiscal year. But one thing is worrisome. The government has kept overall bank credit at Rs42.8 billion by borrowing excessively from the SBP the bulk of which it has used to retire commercial banks' credit.

The SBP data show that between July 1, 2004-January 22, 2005 the federal government borrowed Rs203.6 billion from the central bank. During the same period it retired Rs166.9 billion worth of commercial banks' credit. This enabled it to contain its overall borrowing from the banking system around Rs36.7 billion. Meanwhile, the provincial governments borrowed Rs6 billion from the banking system during the period under review. Thus, the overall borrowing of the federal and provincial governments combined rose to about Rs42.8 during July 1, 2004-January 22, 2005.

Since the government borrowing from the central bank is considered more inflationary than its borrowing from the commercial banks, the government move to borrow Rs203.6 billion from the SBP in less than seven months suggests that its commitment to contain inflation is weak. Year-on-year inflation in the first half of this fiscal year rose by 8.81 per cent, against the initial target of 5 per cent for the entire year. The National Credit Consultative Council has recently revised upwards inflation target to 7 per cent -- and the State Bank has said in its first quarterly report that inflation may settle around 7.6-8.2 per cent.

The NCCC has also revised the target for GDP growth to 7 per cent for this fiscal year, up from the initial estimate of 6.6 per cent.

To keep inflation from rising beyond the revised target of 7 per cent, the government as well as the State Bank need to take concrete steps and both have already been made some serious moves in this direction. The government has allowed imports of wheat and sugar to improve food supplies and the central bank has accelerated the tightening of interest rates. But both need to do more particularly because the factors that can increase inflation are seemingly overweighing the ones that can keep it in check.

One key factor is the increase in petroleum prices, the other is widening trade deficit. In this context that there is an urgent need for the government to contain its borrowing from the central bank. But to do so, the government will have to increase its borrowing from non-bank sources. Sale of long-term Pakistan Investment Bonds during the second half of this fiscal year can be helpful in this connection.

During the first half of the year, the government did not sell these bonds because non-bank investors including giant corporates were not demanding higher yields on these bonds.

As the SBP is now increasing short-term interest rates much faster than in the first half of this fiscal year, this has set the stage for the government to increase the yields on long-term PIBs as well. This will help it increase its borrowing from non-bank sources not only through PIBs themselves, but also through National Saving Schemes as increase in PIBs yield would raise the yields on NSS as well.

In the first five months of this fiscal year, i.e. during July-November 2004, net investment in NSS remained negative. There was a net outflow of Rs1 billion from NSSS instead of net fresh investment.