Its no secret that government borrowing has been increasing incessantly over the last couple of years. The problem is how the State Bank deals with the contrasting pressures of filling the governments loan appetite and yet ensuring the availability of private sector credit from commercial banks.
This, according to the SBP, is a difficult trade off that it has been grappling with for the past several years.
The SBP laments that despite a 450 bps cut in the discount rate over the past 20 months, net private sector lending remains anaemic; whereas banking spreads remain high and the balance sheets of commercial banks continue to skew in favour of government paper.
In trying to solve this problem, it appears that the central bank is taking a cue from an unpublished manuscript titled Dominant Borrower and Endogenous Spreads: The Need to Avoid Corner Solutions, Written by group of scholars, the study finds some interesting insights.
First it argues that interest rates spreads in a country are lower when it has a more developed financial system; as more players aside from commercial banks create a degree of financial competition that keeps spreads low.
It also finds out that "the association of a dominant borrower (read: government and other public sector borrowing) and high spreads, is stronger when the financial system is relatively under-developed," the SBP pointed out.
The reading the SBP took from these is that as interest rate spreads increase (with an increasingly dominant borrower), the government is crowding-out the private sector.
Even more worrisome is the fact that by pulling the growth below its potential, credit risk in private sector lending increases, which in turn incentivizes commercial banks to place even more credit with the government.
This therefore creates a vicious spiral leading to negative implications on employment; tax collection; documentation; policy effectiveness; private investment; per-capita GDP; and many social welfare indicators.
Lastly, the central bank noted that "large banking spreads are more damaging - in terms of keeping GDP growth well below the countrys potential - in those countries with an under-developed financing system and a dominant borrower".
And herein lie some answers for Finance Minister Ishaq Dar: the development of financial system and the need to find alternative source of funding aside from borrowings from commercial banks.
As for the market, perhaps the following SBPs remarks in conclusion of findings from the report warrant some attention:
The analysis "forces us to revisit the twin-mandate of most central banks (price stability and sustainable growth), which could explain why the US Fed; The Bank of England; and the Bank of Japan, have undertaken such an abrupt change in strategy to focus on growth and employment, even at the cost of higher inflation." Is the SBP giving some kind of clue between these lines?
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PML-Ns DEVIATIONS FROM PROMISES
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PML-N Manifesto Budget measures/ direction Remarks
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One-third reduction in current 10 percent increase deducting While the expenditure for PM House has been
expenditure other reduced and discretionary finds discarded,
than salaries, allowances pensions, salaries and allowances. the inability to eliminate subsidies has ballooned
and pensions the current expenditure
No increase in tax rates / Decreasing Standard rate of GST increased from Presumptive tax regime goes one step ahead instead of doing
tax rates to bring down inflation 16 percent to 17 percent away with it. New tax measures are inflationary in nature
Documentation of economy to bring Documentation unlikely in absence of No word on RGST makes it difficult for documentation to take
informal economy into the tax net Reformed GST place. Tax penalty on unregistered tax payers to yield negligible
revenue. The incentive to remain out of the tax net continues
Increasing dependance on direct taxes Direct tax target at 37 percent of total tax
target - similar to FY13
Bank borrowing more than doubled to
Limiting government borrowing Rs974.9 billion compared to the
to keep inflation in single digits budgeted Rs483.8 billion for FY13
Ending of cross subsidy among Inter-disco tariff subsidy continues to With all efforts to clear the circular debt stock tariff rationalization
distribution companies be high - over Rs200 billion has taken a back seat. Continuation of subsidy would undo the effort
of clearing Rs500 billion stock
Narrowly target subsidies to lifeline Ishaq Dar believes the definition of Any tariff rationalization raising the bar of lifeline consumers definition
consumers using up to 100 units lifeline consumers is a lot more than would prove to be a cosmetic measure, yielding little to no fruit
100-unit category
Replace untargeted subsidies Subsidy on imported urea continues - Mechanism of targeting to the right people missing. USC
with targeted subsidies so does Ramadan package at utility stores Ramadan Package has proven a blanket subsidy in the past,
benefiting hoarders. Decision on CNG
and fertilizer feedstock to further determine how argeted
the subsidies will be
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