The country is likely to see the budget deficit ballooning to 6.5 percent of the gross domestic product (GDP), as the State Bank of Pakistan (SBP) on Saturday decided to maintain the policy discount rate at 14 percent. With the federal budget set to be unveiled on June 4, long-awaited out of the box budgetary measures keep haunting the terrorism-marred economy. With the SBP declaring persistent inflation, weak economic growth and low private sector investment clubbed with a large budget deficit the major challenges, the removal of untargeted subsidies in the budget is highly likely. This fiscal gap between the government’s revenues and expenditures would be 0.7 percent higher than the official target of 5.5 percent set for the FY10/11.
“Because of the recent adjustment of old dues reflected in the stock of the circular debt, the fiscal deficit for FY10/11 is likely to increase by approximately 0.7 percent of the GDP,” the SBP said in its Monetary Policy Decision (MPD) taken by its central board of directors for last two months, June and July, of FY10/11. However, the final outcome would depend upon the realisation of the FBR revenue target and provincial surpluses, the bank said.
It said the rising total debt amounted to Rs 11.2 trillion by the end of March 2011 and its servicing demanded an increasing portion of revenue. “At the same time, the GDP growth rate of below 4 percent over the past four years appears to be highly correlated with declining real private investment expenditure and driven by consumption demand,” it said. The SBP said this, coupled with severe energy shortages, was negatively affecting the utilisation and expansion of the economy’s productive capacity. “This implies that the output gap – the difference between aggregate domestic demand and supply – is perhaps widening again, making it difficult to bring inflation down.”
“Thus, along with rising debt, the economy seems to have settled at a low-growth-high inflation equilibrium… these developments highlight a predicament faced by the economy.” The central bank expressed concern over the declining trend in external financing, which has significantly increased the cash-starved government’s bank borrowings. The development is not only leading to the crowding out of the growth-oriented private sector, but also making liquidity management difficult. “The magnitude of such borrowings poses a challenge for effective liquidity management with implications for inflation in FY11/12.”
According to the SBP, the incremental government borrowings from the banking system increased to Rs 614 billion during July 1-May 7 period of FY10/11, a 28.3 percent rise over previous year’s based borrowing. “The borrowings from SBP explain almost 80 percent of the expansion in reserve money, while the banking system’s budgetary borrowings explain 95 percent of the expansion in M2,” it said.
The shortfall in external financing, increase in fiscal deficit on account of security spending, flood impact and the recent one-off adjustment of Rs 120 billion in circular debt were the major reasons cited by the bank for heavy government borrowing.
It said by retiring some loans in third quarter of FY10/11, the government had reduced its borrowings from the SBP to Rs 1.155 trillion by the end of March 2011. The SBP also shifted a portion of this “temporary” borrowing, Rs 61 billion, to the market through an outright Open Market Operation, expecting that the government borrowing would soon converge to the end-September 2010 level of Rs 1.290 trillion.“The year-on-year growth in both reserve money and M2 remains close to 15.5 percent and may increase further by the end of FY10/11, which would be higher than SBP’s earlier projections,” the bank said.
About inflation, the SBP said the average CPI inflation for FY10/11 was likely to remain between 14 and 14.5 percent, which was lower than SBP’s earlier projections. The bank said government’s growing borrowing had also squeezed out the private sector’s credit in terms of banks’ allocation of system’s deposits. Citing the National Income Accounts report, the SBP said the real private investment expenditures in the country had declined by 3.1 percent, while the real private consumption grew by seven percent, leading to a growth of 5.9 percent in total domestic demand. “The basic intermediation function of scheduled banks is being constrained,” it warned.
“For the economy to grow on sustainable basis the debt burden to become manageable and inflation to come down to single digits, the private productive activity and investment would have to increase considerably and quickly,” the central bank said.
