- Thinking important things through
Last week I was watching a talk show program on television on which Mr Shaukat Tarin, former finance minister of Pakistan, was a guest. He praised the prime minister’s imitative to build five million homes in five years. In principle, we all do. When Mr Nizami asked Mr Tarin how such a mega project could be financed, Mr Tarin said that the liquidity in the banking sector could be utilised for this purpose.
Mr Tarin went on to explain that, in the past, housing finance initiatives had not succeeded because the foreclosure laws in our country were not effective due to judicial constraints. He said that this time the government could succeed if, instead of getting the banks to lend directly to prospective home owners, the government borrowed from the banks to finance the homes. He explained that banks would be willing to lend any amount to the government because banks consider government borrowings to be risk free. Mr Tarin was right on both counts. Banks would prefer to lend to the government and this could be the means to finance the housing project. But how much can the government borrow and at what cost?
It is not difficult to calculate the cost of the government’s proposed housing scheme. Assuming the scheme is to build homes for poor people, the smallest functional house will consist of two small rooms, a bathroom and a kitchen in total around 500 square feet. At current prices the cost of simple construction is around Rs1,800 per square feet. That comes to Rs900,000 per home excluding the cost of land. Because of the large scale of the project the government may reap the benefit of economies of scale so the cost may reduce to Rs800,000 per home. Thus the total project cost of five million homes over five years will be Rs4 trillion or $30.7 billion. This assumes zero annual inflation in construction costs and an exchange rate of Rs130 to the dollar, ignoring the cost of land. The figure of four trillion may not seem too large to some people. Its impact on the economy can be appreciated when we note that all loans from all banks combined to the private sector add up to only Rs4.7 trillion.
The government normally borrows from local banks through Treasury Bills of either three months, six months or one year maturities. The government also borrows long term rupee denominated bonds. In both cases there is a cost involved. Banks usually lend to the government at the interbank rate which currently stands at 7.85pc per annum. The interbank rate could be lowered by SBP (the economic implications of this are being ignored for this analysis). So we can assume a long term average cost of, say, 5pc per annum for government borrowings.
Our national local currency domestic debt currently stands at Rs17 trillion. At 5pc per annum this costs the government Rs850 Billion each year. Taking on this mega project at this time will increase our national domestic debt by 25pc and our debt servicing cost will increase by Rs200 billion to over Rs1 trillion per annum.
During the past two decades we have seen massive urbanisation as millions of people have migrated from rural areas to big cities (in search of jobs and facilities such as schools and hospitals)
There is no doubt that these homes are needed. The affordable housing shortage in the country is well in excess of five million. That such a mega project will spur economic activity and create jobs is also not in doubt. The big question is, can we afford it at this time? In the 20th October issue of this newspaper, Dr Ishrat Husain, the former SBP governor, was reported to have said, “Debt servicing is the big elephant. It can only be tackled if we reduce our borrowings, both external and internal”. From this it appears that Dr Ishrat Husain would oppose increasing domestic debt (for housing or other projects). So it seems that the government’s economic and financial advisors are not on the same page.
Land in our cities now being prohibitively expensive, the government would most likely choose rural locations for this project. During the past two decades we have seen massive urbanisation as millions of people have migrated from rural areas to big cities (in search of jobs and facilities such as schools and hospitals). To persuade people to live outside the big cities the government will need to significantly expand its civil infrastructure which will add to the development cost of this housing project. Eminent economist Dr Nadeem ul Haq, who is the former Deputy Chairman of the Planning Commission, is a strong proponent of vertical growth in our big cities (in order to create more affordable housing). He believes the private sector will fill the gap in housing if only the government liberalises property development rules and regulations. Perhaps he is right.
