Who is feeding it?

Government dominance on systems credit is even more this year to date. NFA is in red which was marginally green in the same period last year and private sector credit kept on its streak of negative credit. Government borrowed Rs 242 billion in first four and a half months for this fiscal year; two-third more than for the same period of last year surpassing nominal GDP and money supply growth. But this time around, borrowing has leaned heavily on scheduled banks; not the State Bank of Pakistan-much to the delight of economic analysts, who have long huffed and puffed arguments against the inflationary nature of government borrowings from SBP. Commercial banks have lined up to feed the governments insatiable demand for borrowing. Unfortunately, as banks invest further into short- and long-term government paper and SBP appears complacent; inflation is creeping in to the system through the back door. Net government borrowing from SBP is in negative territory, while close to Rs.200 billion borrowed in the similar period last year. At the same time, scheduled banks are embracing government borrowing with open arms having lent out Rs.275 billion to date in this fiscal year. In the last fiscal year, government borrowing from commercial banks was virtually non-existent on net basis. The investment to deposits ratio of all commercial banks increased by massive 10 percentage points to 51 percent in last nine months while advance to deposits ratio is on a constant decline. What else could be said on crowding out of investment? On net basis, NFA is down by Rs.140 billion relative to the same period of last year. Thus, the banknote printing press is at rest. So, where from are the banks getting money to feed the governments never ending demand? SBP is conducting regular open market operations, injecting about Rs.200 billion, each week. While these are short-term cycles of buying and selling OMOs, essentially the Central Bank is providing commercial banks with the additional liquidity to invest further in T-bills. But, could this be mere window dressing to turn the heads of multilateral lenders such as the IMF who have clamoured against the perils of mushrooming government borrowing from SBP. The mechanics is simple. State Bank injects liquidity in the system by lending on weekly basis to commercial banks to minimise the volatility in the market interest rates. Commercial banks are using all this money and its multiplier effect to channel fresh investments back at the single biggest player; the government. Last year, SBP was lending directly to the government; now it is doing so through the scheduled banks. So, on the face of it, IMFs conditionality of limiting government borrowing from SBP to zero on net basis in each quarter is being met. But in essence its inflationary impact by demand creation is almost same, i.e., money being pumped in the system by SBP to commercial banks routed to government, being used for fiscal gap funding instead of investments. Sooner or later its impact on CPI will be visible. The IMF may even raise eyebrows over the patch work at its Article 4 Review meeting next month. However, short-term economic indicators are improving; inflation tapered down to 11.4 percent in Jul-Sep FY12 and may remain in the vicinity of 10-10.5 percent in October. The LSM index put on 6.9 percent in August showing some signs of recovery. However, both CPI and LSM indices are re-based and better numbers are partially owed to rebasing. Similarly, money aggregate sheet is showing improvement by creating liquidity from alternate channels. SBP pounced on this opportunity to keep real interest rates at zero by slashing the discount rate by 150 basis points in its last monetary policy review. So, is it time to smile, sit back and relax? Or to ponder over the real impact, keeping rebasing and window dressing out of equation? Keep your fingers crossed; December onwards romantic season may be over.

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MONEY SUPPLY                                           1st July to
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(Rs mn)                                         14-Oct-11 P    15-Oct-10
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Net Foreign Assets of the Banking System 2/        92,101         48,579
Net Government Sector Borrowings (a+b+c)          242,362        174,911
(i) From SBP of which                             -43,672        189,166
(ii) From Scheduled banks (net)                   288,062          9,090
Broad Money (M2)                                  -27,109         55,690
From Banking System                               221,969        191,269
From Scheduled Banks                              267,720          9,371
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Source: SBP
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