KARACHI, Nov 23: The federal government borrowed Rs126 billion from the State Bank in the first four months of this fiscal year but used the largest chunk of it to retire the loans obtained from commercial banks.
Data released by the State Bank show the central government retired Rs114 billon loans obtained from the commercial banks out of its Rs126 billion borrowed from the SBP. This reduced its net borrowing to Rs12 billion -- well within the full fiscal year target of Rs47 billion.
For many monetary analysts a huge government borrowing from the central bank was one of the factors that pushed up year-on-year inflation to 9.06 per cent in July-October 2004. In July-October 2003, when the federal government had borrowed a small amount of Rs10 billion from the central bank, the year-on-year inflation was 2.22 per cent only. But central bankers and senior government officials say it is misleading to conclude that heavy government borrowing from the central bank necessarily increases inflation.
They, however, admit that the government borrowing from the central bank is believed to be more inflationary than its borrowing from the banks because it often, but not always, results in currency notes printing and leads to an increase in the reserve money or high powered money.
On the other hand, the government borrowing from banks does not lead to notes printing and it does not increase the reserve money the way the government borrowing from the central bank does.
What encourages the government to borrow excessively from the central bank to retire commercial banks' credit is that its borrowing from the central bank is normally cheaper than from the banks.
The government tends to borrow heavily from the central bank at times when interest rates move up -- and interest rates, particularly T-bills yields that determine the cost of government borrowing, did move up in July-October this year.
The weighted average yields on three-month, six-month and one-year T-bills increased to 3.22 per cent, 3.19 per cent and 3.84 per cent, respectively, from 1.70 percent, 2.07 per cent and 2.19 per cent at the end of the last fiscal year.
Whereas this increase in T-bills rates provides an explanation for a huge government borrowing from the SBP in the first four months of this fiscal year, the reverse of it, perhaps explains why it did not borrow heavily from the central bank in the same period of the last fiscal year.
In the first four months of the last fiscal year, the weighted average yields on three-month, six-month and one-year treasury bills rather fell to 1.46 per cent, 1.61 per cent and 1.95 per cent, respectively, from 1.66 per cent, 1.65 per cent and 2.35 per cent.
When the government borrows from the State Bank, the central bank creates special treasury bills on its books for this purpose and the borrowing is priced at the weighted average yield of the bills at the last auction.
On the other hand, when it borrows from the banks it sells the bills to the banks and the borrowing is priced according to the yields quoted by the banks themselves and accepted by the SBP on behalf of the government.
That is why the government borrowing from the central bank becomes cheaper than its borrowing from the banks at times when the interest rates are on the rise. The central bankers and government officials say it is not appropriate to presume that the government borrowing from the central bank would eventually lead to additional notes printing and that it would necessarily push up inflation.
They say that the government borrowing may lead to additional notes printing in case the demand for currency is more than the production of goods and services. "If the government is borrowing excessively from the central bank but the economy is growing, the production of goods and services is up, then it would have no impact on inflation at all," said a central banker.
The latest monetary data indicate that the federal government's borrowing from the SBP that stood at Rs126 billion between July-October 2004 shot up further to Rs149 billion on November 6. The data show that this huge borrowing enabled the government to retire Rs127 billion credit obtained from the banking system, thus keeping its net borrowing at Rs22 billion.
An unusually large increase of Rs23 billion in the government borrowing from the SBP within a week shows its inability to raise the desired amounts of loans from the commercial banks at the desired rates so far during this fiscal year.
The bankers and officials say the pattern of government borrowing may change in the times to come, implying that the government borrowing from the central bank may shrink and its borrowing from banks may rise in future.