WILL the ‘populist’ budget approach be helpful in forging closer fiscal and monetary coordination to combat inflation and stimulate economic growth?
“Unfortunately, I don’t find in the new budget anything that can be helpful in stabilising the exchange rates—plans for privatisation or launching of sovereign bonds or even any incentive scheme for overseas Pakistanis (whose home remittances have saved the country much pain on the external sector).”
The federal budget has, however, proposed Rs10 billion to be spent under Export Development Fund to enable export-oriented industries to earn more foreign exchange.
The tax incentives and relief proposed for the next fiscal year means continuation of government borrowings from the banking system. For the SBP, keeping the market liquid enough (to facilitate government borrowing from banks at reasonable interest rates) would not be that easy. “Frequent injections of additional money in the system (ahead of auction of treasury bills and bonds) have their own complexities.
They don’t always work to facilitate enough government borrowing from banks without allowing interest rates to rise. Besides, they also have unfavourable indirect effects on the health of the local currency,” explains another central banker.
A key question is : does the budget promise cuts in government spending and ensures expansion in tax and non-tax revenue? Federal Finance Minister Hafeez Shaikh says the government has brought down the cost of its day to day operations by 10 per cent in the current fiscal year..
Even if it is assumed that the trend would continue next year there are many other things—including tax-relaxations and lack of substantial inflows of foreign funding—that would keep government expenses up. Much would depend on meeting the targets for overall economic growth and tax revenue as well.
Central bankers and government officials agree that achieving the targeted economic growth and keeping inflation within the desired level are the ultimate tests of the quality of fiscal and monetary coordination. Since both targets for FY12 were missed, there must have been some missteps. Government officials say that SBP did not make substantial cut in interest rates to facilitate industrial growth.
Central bankers argue that excessive government borrowing from the central bank fuelled inflation making it difficult for them to make deeper cuts in its policy rate.
They say that the SBP decision a few months ago requiring banks to offer at least six per cent return on saving deposits was one of the many examples of how monetary authorities were also creating an enabling environment to rake in savings and help achieve economic targets.
Monetary authorities coordinate with the government to achieve key economic targets in many ways including interest and exchange rate management and maintenance of discipline in the financial sector. Central bankers claim they have been successful in each of these areas.
“We introduced interest rates corridor (during the present political regime) to ensure proper utilisation of banks’ liquidity. We went for policy rate cut when we found room for it. We maintained a healthy volume of foreign exchange reserves despite severe pressure (at times) on the current account and balance of payments and we often warded off volatility in exchange rates,” boasted a senior SBP official.
But on the fiscal side, inability of the government to keep fiscal deficit within the targeted level in FY12 in spite of double-digit growth in tax revenue poses a challenge for the next year as well. Part of fiscal deficit was admittedly due to the reasons beyond government control (like flood-related spending) but part of it (like over-spending by government departments and ministries) could have been controlled more efficiently. Some fiscal space could have been created by reducing heavy losses of Pakistan Steel, Pakistan Railways and Pakistan Steel etc.
And huge amounts of subsidies on power sectors could also have been reduced by forcing power distribution companies to recover tens of billions of rupees stuck up in overdue bills. Surprising, the new budget too does not offer hope of how these issues would be dealt with effectively in the new fiscal year.
But all is not bad. The budget includes some steps for reducing smuggling like proposed cut in maximum customs duty and reduction in sales tax on tea. If supplemented by administrative checks, these steps would help in plugging in some revenue leakages.
Government officials say the budget has set the stage for better economic conditions in the next fiscal year. They are generally confident that support from monetary authorities would continue to realise the budget objectives. But some of them privately talk about what is lacking. “We have the widest banking spread in the region which makes bank loans costlier and hinders industrial growth. Our banks also are shy of meeting borrowing requirements of agriculture sector and SMEs,” lamented an official of the Ministry of Finance. “The SBP should take additional steps to bring down the banking spread and to facilitate more judicious distribution of bank credit. That really affects the economy.”
Government officials also complain of banks’ failure in attracting sizable investment of individuals and non-bank companies in treasury bills.
“We allowed individual investment in TBs (in FY12) to increase non-bank borrowings. But we don’t regulate the banks. The SBP does. I wonder why banks haven’t made any efforts to make this scheme a real success,” questioned an official involved in domestic debt management.