Outsourcing govt borrowing!

27 Feb, 2023

On Friday Feb 24, a news report appeared in this newspaper that the ministry of finance (MoF) is working on a plan to outsource government borrowing aimed at getting money from public at less rates than from the banks. This is quite a serious and worrisome news, as the size of holdings by banks & non-banks of the government of Pakistan (GoP) Marketable Securities is a whopping Rs 16.885 trillion.

As per the report, the idea is to get cheaper funding from the public as the banks are charging exorbitant rates. The banks, in fact, do seek larger returns at every auction. It is also true, however, that since the Covid-19 outbreak, inflation has surged and the nature of the business cycle has changed.

The new normal is entirely different from the old one. The fact is that we were never adequately prepared for the arrival of the new normal. For tiny gains, we continued to focus on challenges at the micro level. We failed to acknowledge and make the necessary adjustments when the trend and direction of the global economy changed.

The pandemic crisis stimulated innovation throughout the world, including digitalization that caused a dramatic increase in online business. The world is advancing quickly towards the fourth industrial revolution as it races to capitalise on the growth of e-commerce and to have better access to technology and digitalization. We chose visionless policies during this time and exhibited complacency with the result that due to domestic and political strife, our suffering increased to an unbelievable degree.

In the past, I have made countless appearances on television talk shows and have written numerous articles underlining the fact that our economy is deteriorating quickly and that we must make macroeconomic corrections otherwise we would face very challenging times. These warnings remained an unheeded cry in the wilderness.

HOW & WHY?

Due to quantum increase in POLICY RATE, mark-to-market (MTM) losses for the banks on fixed income bonds have increased sharply into hundreds of billions of Rupees that will have a severe negative impact on their total Capital Adequacy Ratio (CAR). It will potentially affect tier I CAR, if and when the impact exceeds the limit, resulting in more MTM losses. A one percent hike in policy rate, it is estimated that the financing requirement increases by roughly Rs 275 billion to 300 billion. This, also means that ADR of a good number of banks, which is hovering around 50% or slightly above at present could restrict them to lend further (capital constraint).

There are credible reports that the State Bank of Pakistan (SBP) is fully aware of the situation and is being urged to consider some relief/relaxation for banks to avoid revaluation losses on GoP paper. The risk is, that if banks are not allowed to employ the amortised cost method, liquidity will be clogged until maturity. As it is, there is a severe liquidity crunch due to debt/deficit, which is why SBP’s open market operations (OMOs) have surpassed Rs 6.4 trillion (Commercial & Islamic). I had already forewarned the SBP think tank at a meeting in March 2021 that the change in strategy would likely drive the amount of OMO injection to exceed Rs 5 trillion.

The problem is that with the ‘Held to Maturity’ (HTM) portfolio, banks are committed to hold these securities until maturity, as they are not allowed to sell. HTM securities in exceptional circumstances have previously been allowed to be accounted for by employing amortised cost method by the SBP.

The SBP’s shift on policy rate in 2019 from a focus on core inflation to headline inflation, in my opinion, was a flawed measure. Had this shift not occurred the rate at which the policy rate has increased would have been at a much slower rate.

Due to the unfavourable conditions in the international bond market, a number of banks are also having trouble with their portfolio investments in foreign bonds, which may amount to about USD $1 billion. The effects on the PKR and foreign currency will have an influence on capital adequacy. As a result, some voices in the marketplace are urging the rescheduling of debt, which is a lengthy procedure.

There is no doubt that the recent floods have worsened the economy. The IMF ought to have provided some leeway, fiscal space, and a waiver in this dire situation. Pakistan would have to develop a presentation and a plan before asking for a moratorium.

Coming back to the news report, such a move will undoubtedly draw attention and possibly raise questions about transparency and poor management. Furthermore, I feel that such a move may not be successful. Another serious problem is the fact that banks have already committed to circular debt. OMOs are carried out against securities too; it should be noted. It also has Basel implications, and more critically, how the accounting standard will be used.

I have my reservations whether the shareholders of United Bank (UBL), Allied Bank (ABL) and Meezan Bank will permit their managements to take the investment risk. National Bank of Pakistan (NBP) can participate with the approval of its major shareholder (GoP). The foreign banks would need authorisation from their head offices. The other institutions will also be reluctant to take part.

The amount of Currency in Circulation (CiC) is rising dangerously. Via Open Market Operations (OMOs), SBP has been putting money into the banking system to give banks more capacity to lend to the government.

If MoF believes that banks are ineffective in bringing CiC into the banking system, it can use its influence over National Savings Scheme (NSS) or Islamic Treasury Products to draw small savers into the formal economy. The government should act as an enabler to document the economy rather than competing with banks, as the report in Business Recorder suggests.

Copyright Business Recorder, 2023

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