The State Bank of Pakistan (SBP), expressing his views over soaring government budgetary borrowing from domestic sources that has piled up to Rs5.594 trillion, said such a sharp growth in debt stock is fueling concerns about the macroeconomic stability and monetary management of the country.
The SBP, therefore, has termed it necessary for the government to adhere to fiscal discipline and restrict its borrowing from the central bank to contain inflationary expectations “which have become ingrained in recent months”. Also, the State Bank has asked the cash-starved government to rollover the entire stock of Rs2.854 trillion of short-term debt at least once a year to avoid interest rates-related risks, arising from a possible surge in credit demand from other sectors.
The central bank has also proposed to the resource-constrained government that rationalisation of the gas tariffs for various consumers would be a “better policy option” to create incentives for further exploration and extraction of this scarce source of energy. “The impact of the widening fiscal deficit was clearly visible in the sharply rising domestic debt,” the regulator observed in its Third Quarterly Report on the State of Pakistan’s Economy for FY11 released Monday.
It said the outstanding government domestic debt had reached Rs5.594 trillion, accounting for 31.8 per cent of the estimated GDP, which is more than double the stock at end-June 2007. “For effective monetary management, maintaining government borrowings from SBP at end-September 2010 levels will be critical,” the bank emphasised. In addition, it said, the maturity profile of domestic debt revealed that the government had to rollover the entire stock of Rs2.854 trillion of short-term debt at least once a year. “Any surge in credit demand from other sectors of the economy could elevate rollover risk, and could also expose the government to interest rate risks,” the SBP warned. In terms of fiscal management, desirable revenue generating measures such as broadening of the tax base, improving documentation of the economic system, gradual elimination of un-targetted subsidies and curtailment of quasi-fiscal operations, were necessary to contain the fiscal deficit to below 4.5 per cent of GDP in FY12, the central bank said. It further added, “These efforts need to be accompanied with better debt management to increase the tenor of domestic debt and lower risks associated with debt re-pricing and rollover.” According to SBP, the country’s growth outlook in FY12 would be shaped by policy responses to several key domestic challenges including energy shortages, which are restricting growth; the high fiscal deficit whose financing has become difficult, partly owing to the backlog arising from the non-recognition of power sector subsidies of earlier years as reflected in the circular debt, build-up of domestic debt, rising concerns for macro stability and inflationary pressures which were not receding readily.
“In overall terms, although the post-flood hike in CPI inflation has largely dissipated, inflation is persistent and in excess of 13 per cent,” the bank said. The State Bank cited the lagged impact of government borrowings from SBP during Jul-Sep 2010; frequent upward adjustments in utility and POL prices; increase in commodity prices and rising trends in house rent index (HRI) as possible reasons for inflation in the country. It said the government was facing difficulties in containing the fiscal deficit. The SBP stressed that implementation of fiscal reforms still poses political challenges. “For instance, structural problems that require difficult policy decisions for fiscal consolidation (e.g. expanding the base of GST through the withdrawal of exemptions, tax on agri-income, and restructuring and privatisation of PSEs) are awaiting resolution and in anticipation of multi-partisan consensus,” the bank added. As far as financing is concerned, the bank observed that the government had had little option but to rely on domestic sources to finance a growing fiscal gap. More specifically, while borrowing from SBP was largely contained at end-September 2010 levels, from April 2011 onwards, the government borrowed over Rs350 billion from SBP during March 31-May 3 2011. This was largely meant to internalise the growing quasi-fiscal expense, e.g. the circular debt in energy. The bank added, “In other words, this borrowing is actually financing the carry-over of quasi-fiscal deficits from previous years.”
Textile exports managed to register strong growth despite efforts by competitor countries to hinder concessionary access of Pakistani products in developed markets, the bank said and added that steady growth in remittances was a welcome development. For the first time in Pakistan’s history, monthly remittances crossed the $1 billion mark for two consecutive months, March and April 2011.
“This comfort from the external account together with broadly contained government borrowings from the central bank, allowed SBP to hold the policy rate at 14 per cent in the last three policy announcements (January, March and May 2011).” These decisions revealed a shift when compared to the cumulative increase of 150 basis points (bps) implemented during H1-FY11, the bank said. “Provisional estimates put forward by the National Income Accounts Committee show GDP growth at 2.4 per cent for FY11, lower than the growth of 3.8 per cent in the previous year. In the context of the prevailing security concerns, an exogenous shock from rising oil prices and the impact of the unprecedented floods, this decline is broadly in line with SBP’s expectations,” the bank said.
It said that on a positive note, the post-flood recovery in wheat, sugarcane and minor crops helped agricultural growth surpass previous year’s level. However, rural incomes might not rise proportionately due to lower market prices of wheat and rising input costs, e.g. diesel and fertiliser, the bank said. In the manufacturing sector, the State Bank said, demand for products, particularly textiles, automobiles, fertilisers, cement, and POL remained strong. Nevertheless, despite the strong demand, supply constraints, particularly the shortfall in energy, created production bottlenecks, which led to a significant slowdown in industrial growth. Moving forward, the SBP said, one of the policy challenges was to distribute available gas supplies efficiently amongst competing users.
“Keeping this in view, the ECC (Economic Coordination Committee) recently decided to divert gas supply to the fertiliser sector, recognising the importance of stable agricultural input prices and saving foreign exchange on imported fertilisers.”
Furthermore, the potential role of imported gas is unquestionable in the medium-term, and policy emphasis must be directed towards developing the necessary infrastructure to use imported gas, the bank said.
“More importantly, a better policy option is to rationalise tariffs for different users of this scarce resource and improve the gas pricing structure to incentivize further exploration and extraction,” it suggested.
