Curious case of money creation

In June 2007 the outstanding stock of government borrowing from the State Bank was less than half a trillion rupees. It was all hunky dory as the foreign flows were pumping in whilst domestic economy was thriving. Then we embraced the global financial crisis with disgrace by running huge subsidies, as the government shielded consumers from sky-rocketing oil prices. Within a year the stock of government borrowing from SBP more than doubled as the central bank printed close to Rs.700 billion in FY08 – an election year. The new government came and took a fresh start; taking the bills already printed as a permanent feature and high powered money creation has been the order of the day, every day since then. By the end of FY12 stocks of government borrowing from SBP stood at Rs.1.7 trillion. There is a lot of hue and cry on this continued printing of pictures of Jinnah by IMF, eminent economists and it is this monetary overhang that has made easing the monetary policy a tough choice for SBP. So what happened in the last year or two is that the onus of government credit management is divided amongst the central bank and commercial banks. Since July 2011 to-date government borrowing from SBP and commercial banks stood at Rs.135 billion and Rs.1,225 billion, respectively. On the surface, it seems good that money creation has halted. But, there is a catch. The stock of money injection from the reverse open market operations – the discounting window used by commercial banks to maintain system liquidity – crossed Rs.700 billion. This is an abnormally high number and increasing. The usual case is of mopping up of liquidity in days of heat and injecting it during dry seasons; but it is short term in nature. However, lately it is becoming a consistent feature of injections of liquidity by SBP and there is a fear of this becoming part of permanent debt. This is not different from borrowing from SBP as this permanent liquidity injection is effectively high powered money creation. The premise of the permanency argument is augmented by the recent precedence of converting some credit of commodity operations to part of government permanent debt, i.e., converting to T-Bills and PIBs. The commodity operations used to peak around Rs.150-200 billion at the time of wheat procurement. Subsequently, this tally would drop to Rs.70-80 billion by the year-end. But, after the wheat support price was fixed a few years back, the stock of debt piled up to support commodity operations has risen unimpeded to over Rs.400 billion, even after some component of this tally was converted to long-term government debt. And the case of stickiness of OMO injections becomes even stronger considering that this is an election year. Drawing parallels from what happened in the previous election year, it seems obvious that the honeymoon season of low inflation will soon give way to the drudgery of fast-rising prices once more.