The recently released monetary policy statement emphasizes the inflation-stoking hefty government borrowing from the central bank as well as the rollover risk associated with fiscal financing through the T-Bills auction. Yesterday, the T-bill auction target announced by the finance ministry for second quarter validates such risks.
The government has set the target of raising Rs685 billion through the combined auction of 3, 6, and 12-month papers in the second quarter, against a maturity of Rs647 billion which it has to pay back to scheduled banks and primary dealers in the same period.
Hence, the government can only use Rs47 billion to retire a part of its Rs220 billion it took from the central bank between July and September 24. However, given the poor tax collection observed in the first two months and a dearth of foreign budgetary support, the chances of meeting IMFs net zero quarterly borrowing target from SBP are low.
During the Jul-Sep period, the ministry of finance raised Rs542 billion through market treasury bills against the maturity of Rs532 billion. The selling was skewed towards the even shorter tenure of three months with two-third of the amount raised in said tenure. Now this will be maturing in the second quarter, putting more pressure on rolling over, given the fiscally constrained conditions.
That could be one reason for higher targets for Oct-Dec period. The intriguing fact is a raise in the policy rate by 50 basis points, market participation might be shifted a little from 3-month to 6-month and 12-month tenors, at least in the auction due in October in which the government plans to raise Rs175 billion.
Later, inflation numbers in the coming months, foreign budgetary flows, implementation of reformed GST and the Damage and Needs Assessment report being prepared by the multilateral agencies will drive the expectation of the next monetary policy decision and hence the participation tenor of market players in T-Bill subsequent auctions.
Nonetheless, as aptly stated in the monetary policy statement "given the heavy borrowings from the scheduled banks over the last couple of years through short-term Treasury Bills there is a significant
ollover risk during FY11.
Fresh borrowings from the banking system during FY11 will increase these borrowings even further, especially if the spending requirements increase and there is no commensurate increase in tax revenues." The excessive reliance on market treasury bills and the central bank for fiscal financing might continue.
However, the SBP Act which is likely to pass in FY11 may restrict the governments central bank borrowing to 10 percent of FBR receipts. That will restrict the government in raising funds to the tune of Rs160-170 billion for FY11. It will also force the government to knock again on the doors of scheduled banks which may crowd out any demand from the private sector.
Nonetheless, unless that Act is passed, the paradox will remain that although interest rates are raised to combat inflation, which is partially owing to high-powered money creation, the government may even continue knocking the door of central bank more for its fiscal appetite owing to higher interest cost and lack of other avenues. And this in turn will fuel further inflationary expansions.