THE total outstanding domestic debt at 47.4 per cent of GDP at the end of FY99 declined to 32.5 per cent at the end of FY05, says the latest SBP annual report.
An analysis on the basis of economic classification of domestic debt showed that the permanent debt, which was invariably composed of long-term maturity of the principal debt — with a relatively lesser burden of debt servicing — was 20.2 per cent of the GDP. The floating debt (short-term), on the other hand, and unfunded debt (short and medium-term) were 31.4 per cent and 34.3 per cent of the GDP respectively in the same year.
In the latest Pakistan Economic Survey, the federal finance division, being the custodian of the domestic debt, appeared to be quite comfortable and contended with the significant decline in the outstanding domestic debt to GDP ratio and attributed the same achievement as one of the factors of successful macroeconomic policy pursued by the Musharraf government during the past six years.
However, as per international practice, the debt management policy of any country cannot be seen in isolation away from different variables of its fiscal and monetary policies.
An important negative development in the existing debt management policy was the continuation of the government practice to borrow more directly from the central bank (State Bank of Pakistan) then to raise the requisite funds through the auction of government securities. It was a deviation from the system installed as a result of the introduction of debt management reforms under the World Bank’s Financial Sector Adjustment Loan (FSAL) in 1991.
Needless to state, the borrowings from the central bank either by the government or by banks against the government securities is considered inflationary than raising funds through the money market. The reason is that under the former mode, the central bank purchases treasury bills by providing cash credit to the government by printing more currency notes, which in the due course of time find their way to the market.
While in the later course, the primary dealers purchase the government securities at the auction by supplying funds to the central bank out of their deposits, which in technical terms is called ‘mop up’ of liquidity from the market by the central bank which, of course, is an anti-inflationary measure.
As per international best practice, the central banks accept the bids of the primary dealers in the market-related government securities strictly according to the pre-announced auction target set by the treasury and not taking into account the movement of interest rates.
They argue that the auction was purely a fiscal instrument and being the agent to the treasury, the central bank was supposed, in ordinary course, to adhere to the pre-auction target. To control the market interest rates, the central banks have a separate monetary instrument at their disposal and that is the ‘open market operation,’ which is conducted on a fixed periodical basis to regulate the liquidity in the system.
Another international practice in vogue is that the primary dealers are not encouraged usually to approach the central bank’s discount window to borrow funds against the market-related government securities when there is a liquidity crunch in the money market.
Their argument is that bank borrowings from the central bank against market-related government securities should not be encouraged at all as the same has proved a vital deterrent in the development of the secondary market for the market-related government securities in many countries. The main advantage of having a developed secondary market is that the price of the market-related government securities prevailing in this market act as a benchmark price, which helps the bidder of the same securities to offer the bid price at the auction, which is called the primary market for these securities.
It may thus be concluded that the primary market for the market-related securities can function smoothly and efficiently only when the secondary market for these securities is functioning properly.
A well-integrated secondary market means that the sale and purchase of the market-related securities is taking place between the primary dealers and the non-primary dealers, which should include the non-bank institutions, corporate sector and the general public.
Under such integrated trading of the market-related securities, there should not occur a liquidity crunch in the market and the primary dealers need not approach the central bank’s discount window to borrow in their own interest. The domestic debt management reforms introduced in Pakistan in 1991 were designed, among other objectives, in accordance with the international best practices.
Unfortunately in Pakistan, even after a lapse of more than a decade, the core issue relating to development of secondary market for market-related government securities has not yet been taken up aggressively either by the finance division or the SBP.
The first glaring example was that of the Federal Investment Bonds (FIBs), which were issued by the GoP in 1991 and were abruptly withdrawn in 1998 as the finance division was reportedly not comfortable with paying higher rates of return at 15 per cent per annum on their 10-year FIBs.
There were no two opinions among the market players that the FIBs failed only due to the absence of a viable secondary market for long-term fixed income securities.
Although after a long gap of two years the GoP re-issued long-term bonds in the name of Pakistan Investment Bonds (PIBs) with a relatively lower rate of return, the fate of the same does not appear to be different from FIBs, again, only due to the non-development of a secondary market for these securities.
The importance for a full-fledged long-term fixed income securities market, which has been historically experiencing the lowest savings and investment rate in South Asia, cannot be overlooked.
Another example relates to the ‘open market operation,’ which is basically conducted by the central banks two-way to manage the liquidity in the system, which ultimately regulates the short-term interest rates in the money market. On the contrary, the SBP has been largely conducting one-way OMO as has been reported on page 118 of the latest SBP annual report: “SBP’s open market operations in FY05 were predominantly geared towards mopping up liquidity in the market. Out of fifty OMOs in FY05, only three were for injections.”
The OMO is the secondary market for short-term market related T-Bills and the SBP should allow both selling and buying operations in these T-Bills freely to control the short-term interest rates in the money market.
The one-way OMO has not been helping the SBP effectively to manage the liquidity in the system because of the fact they have simultaneously opened the 3-Day repo facility (discount window) wherefrom the banks can borrow funds at a penal rate (presently 9.5 per cent per annum), which is slightly above the prevailing yield on T-bills.
Truly speaking, the SBP seems to be helpless in discharging such an unconventional act as under the existing rules, the SBP is supposed to replenish the cash balance position of the finance division when the situation warrants by creating fresh treasury bills (MTBs) at the weighted average yield arrived at, at the last T-bills’ auction.
As per the latest data on domestic and public debt outstanding given in the SBP report, government borrowings direct from the SBP under the sub-heading ‘MTBs for Replenishment of Cash’ has undoubtedly declined from the outstanding level of Rs508,364 million as at end June, 2001 to Rs197,744 million as at end June, 2004. Nonetheless, there was a sharp increase of 64.3 per cent to Rs324,944 million as at end June 2005 in the stock data under this head.
The situation on this account has further deteriorated as the stock data of MTBs for replenishment of cash has increased by Rs132,571 million during the current financial year up to November 12, 2005 as reported on the SBP website. The unabated increase in government borrowings direct from the SBP has been instrumental in escalating both short-term debt overhang and monetary overhang, which is a challenge equally for the MoF and the SBP.
Instead of increasing its reliance on borrowings direct from the SBP, the MoF should raise funds extensively through the auction of T-bills. Similarly, the auction of long-term PIBs should be held frequently so that the ratio of permanent debt to total domestic debt is increased considerably in the long-run.
The SBP on its part should utilize the OMO aggressively for liquidity management purposes and continue with the existing tight monetary stance preferably by raising the present 3-day SBP repo rate. The increase in the discount rate will provide leverage to the SBP to raise the cut off yield at the auction of T-bills, which in turn will prove a deterrent both for the MoF and the banks to borrow directly from the SBP.