CIC reduction – finding patterns

The economy is showing strong recovery signs as depicted by high-powered data. The buildup of monetary aggregates in the first two months of the fiscal year substantiate the assertion. Though, seven weeks’ data cannot be used to make a trend, the signs are telling.

The currency in circulation (CIC) buildup is reduced to Rs163 billion in 7-weeks FY21 versus Rs447 billion in the same period last year. Overall M2 decline is similar – implying the bank deposits are showing better trend. That is the story of the liability side.

On monetary assets, the share of Net Foreign Assets (NFA) is building at a faster pace – Rs334 billion this year so far versus Rs255 billion in the similar period last year. The decline in net domestic assets (NDA) is high due to retirement of government loans in the domestic banking system – replaced with foreign loans.

The CIC build up in the past 3-4 years has been a big headache for the government. Just last year, Rs1.2 trillion – bigger than a mid-size bank - were added to cash in circulation. This CIC to M2 ratio started moving up from its historic average in 2015 when WHT was imposed on withdrawal of cash from banks on non-filers. Thereafter, the CIC build up can be linked to enhanced efforts of documentation – last year’s number is a manifestation of it.

The sticks were clearly not working. Under the COVID package, government gave some carrots to the undocumented economy in the shape of construction package and general ease on the mantra of documentation. However, the need for documentation cannot be over-emphasized. The ways to lure the cash economy into the mainstream system has to be changed. One way is to reduce the frictions on the digital side – by lowering the fees and enhancing interoperability. The other element is to reduce the GST rates in VAT mode. The tax collection can be compensated by having higher taxes on petroleum.

It is early to say that CIC reduction could become a pattern. On the asset side, NFA buildup was much required and is good for inflation expectation. Inflation is indirectly linked to NDA to NFA ratio. The NFA is growing due to more foreign money coming in for budgetary support. Due to COVID, IMF, WB and ADB gave loads of money to the government.

Then there is the recent shift of a billion dollar of KSA for balance of payment support by China’s budgetary support. In reserves, it is billion in and billion out. But for government, it is a good sign. This money can be used for budget expense and that reduces the need from domestic banking system – this can open more space for the private sector.

The budgetary borrowing from banking system was minus Rs74 billion in the first seven weeks of last year. This time, the reduction is Rs342 billion in the same period. The main decline is in loans from SBP – as it retired Rs562 billion this year versus borrowing of Rs17 billion in the same period last year. From scheduled banks, government borrowed Rs262 billion this year as compared to retirement of Rs86 billion same period last year.

The private sector retirement in the early part of a fiscal year is usual. But the retirement has grown from Rs107 billion last year to Rs157 billion this year. This higher decline could be due to COVID; but with lower interest rates, higher tax collection, and economic recovery, borrowing by private sector may pick up soon.