Finance Secretary’s response to Senators

By: ASAD RIZVI (KARACHI)   Published on June 15, 2015
This refers to a Business Recorder news item about Secretary Finance’s response to Senators’ proposals to finalise recommendations for the Finance Bill 2015. Data provided about government securities by the Secretary Finance is correct. He also said that fiscal deficit is being reduced through a reduction in government reliance on borrowings, which is also true.

But the key question that needs a plausible answer is wheterh Pakistan’s economy is getting badly caught in a debt web due to government’s failure to collect enough revenue to plug the gaps.

Rising debt that has breached the fiscal limits is a very crucial subject, which requires more evaluation and serious discussions to determine the debt cost factor and how to reduce its size and servicing cost.

For years, due to a fall in revenue targets, application of financial engineering techniques is employed as a tool to show country’s balance sheet in an order. Initially money printing strategy worked well, but cracks have started to appear as this skill is no more workable.

Economies cannot artificially survive forever on direct or indirect government borrowing to meet its expenses unless a fair taxation policy is implemented. The secret of our economy’s survival is excessive sale a of subsidised government paper to banks.

Here is the proportion of government securities sale that needs to be defined to understand the quantum of risk attached. Investments by Schedule Banks in Pakistan investment Bonds (PIB) is Rs 2.904 trillion, GOP Ijara Sukuk (GIS) Rs 300 billion and Treasury Bills Rs 1.859 trillion, which totals to Rs 5.063 trillion of the total Bank deposit holdings of Rs 8.911 trillion.

Since November 18, 2013, SBP slashed discount rate by 300 basis point. But, as the pace of cut in discount rate and coupon rate in earlier part was too slow, which is why the average cost of debt financing is still hovering around 10 percent.

Some easing of pressure on borrowing cost due to a cut in discount rate in the shape of a reduction in financing country’s debt will start to deliver some good results in coming months, as government bond matures and new paper is issued at a lower premium. The estimated size of combined T/bills and PIB maturity until FY 2016 will be around Rs 3 trillion.

However, in calendar year 2016, PIB rollover amount is roughly around Rs 1.5 trillion, but T/bills that have short-dated maturities (90 days to 365 days) will comfortably surpass Rs 2 trillion mark by the end of FY 2016, exceeding its current holdings (Rs 1.859 trillion), as the government is likely to miss its ambitious revenue collection target of Rs 3.1 trillion and hence, it will be compelled to offer more T/bills/bonds to settle payment of matured transactions.

Hence, the effective use of managing liquidity and discount rate as a monetary tool is extremely crucial and sensitive, which requires a good understanding. Major components of our economy are growth, unemployment, poverty and prosperity, which are dependent on real economic growth.

No matter how much claims of economic recovery or economic well being are made, the cost of poor fiscal and monetary management will end up in the shape of piling of debt.

Therefore, if policymakers fail to sense the urgency of a further rate cut and PIB coupon rate cut or opt for a discount rate hike in future, debt financing amount will surge at same ratio/pace, which has so far proved very uncomforting for the economy.

Further, if we peep into the country’s balance sheet, based on data available, the claims of a reduction in fiscal deficit are correct, but such measures are temporary, costly and unhealthy for the economy.

A detailed research of data will tell us that it is done through application of a financial engineering method. Instead of direct government borrowings from SBP, to meet the IMF demand, a reduction in Broad Money (M2) growth was made possible by cheap central bank lending to commercial banks through its frequent open market operations (OMOs) and USD/Rupee buy/sell swaps that help liquidity injection into domestic market and simultaneously suck USD Dollar from the inter-bank market amounting to USD 1.72 billion, which becomes part of FX Reserves.

Subsidized funding through OMOs (Rs 623 Billion as of June 12) encourages banks to borrow inexpensive money to invest in least risky high yielding government paper. It kills two birds with one stone. The government does not have to borrow from SBP and at the same time spending is discouraged that helps in containing deficit.

The cost of this lost proposition can be determined through the fact that the SBP “Target Rate” is currently 6.5 percent and average spread earning against PIB is well above 2.5 percent.

However, circular debt is an annual non-ignorable book entry, which becomes a part of fiscal deficit when settled. Last time it was adjusted about a couple of years ago; its current un-adjusted size has inflated to almost 1.75 percent of the GDP. Circular debt annually grows by nearly one-percent of GDP.

Copyright Business Recorder, 2015