Fiscal novelties

Economists are awestruck by the data on central government debt released by the central bank last week. Roughly, the debt has increased from Rs24 trillion as on June 3, 2018 to Rs32 trillion – an increase of Rs8 trillion or one-third during the year closed on June 30, 2019. As percentage of GDP, the debt is 83.

Since debt is accumulated deficits in the past and capital losses on external loans because of devaluation, one is tempted to ascertain the level of last year’s deficit from the debt data. The official deficit number will not be available until the end of the month. Apart from working out the deficit, we also consider a couple of unconventional methods adopted by the government in penultimate hours of the last fiscal year.

Obviously, the increase in debt of Rs8 trillion is not the deficit. Two adjustments are required – loss of capital due to devaluation, and increase in government deposits with the banking system – to arrive at the deficit number. For a moment, without contesting, we take both these numbers as those announced by the minister for economic affairs in a tweet a few days ago. According to him, the impact of devaluation was Rs3 trillion and increase in deposits was Rs1.2 trillion. This takes the adjustment to Rs4.2 trillion. Excluding this number from the increased debt gives us Rs3.8 trillion, which then is the estimated deficit.

This is an unprecedented level, about 9.8 percent of GDP, not seen in at least last three decades. The deficit was originally pitched at 4.9 percent (or Rs1891 billion) in the budget given by Miftah Ismail and marginally adjusted to 5.1 percent (or Rs1967 billion) in the mini-budget announced by Asad Umar in October 2018. Clearly, the final outcome is way higher than these estimates.

However, what is of particular interest to us is the report that deposits in the banking system rose by Rs1.2 trillion. This is a phenomenal amount. As on June 30, 2018, the stock of government deposits was close to Rs2 trillion. This stock has been accumulated since government deposits started slipping into the banking system, a development essentially crept in after the private banks achieved ascendency in the banking system.

It is important to understand how deposits can rise by such an unprecedented amount in one year. Although not officially announced, some have surmised that this has been done to institute a new system to replace government borrowings from the central bank. The deposit, it is said, would help meet any shortfall in borrowings relative to target during auctions. This is a novel development and not much information was provided as to how it will work.

Undoubtedly, as we have said many a time in these pages, of late the government had seriously abused the central bank facility of borrowing. As much as Rs6.7 trillion was the stock of government debt owed to the SBP as on June 30, 2019 – about half accrued during the last year. But correcting it in a one-shot would pose major difficulties.

First, it must be recognized that in public accounting, which is based on cash and not on accrual basis, debts are incurred to finance expenditures not met from own revenues. What kind of demand for grant was created to incur such a huge expenditure? Obviously, since it seems to have been done on the last day, no such demand existed and, therefore, it would be done through a supplementary grant. Given its novel nature, the propriety of such an arrangement would require consultation with the controller general of accounts and the auditor general of Pakistan.

Second, huge borrowing has been done through treasury bills (TBs) at a very high rate close to 14 percent and kept in the central bank, which under law would not pay any interest to the government. This a very high cost to the public exchequer to maintain the buffer. Also, since this was done most likely in three-month TBs, there would always by a demand to refinance this buffer.

As for its use, consider the fact that a TB auction was held in the last week of July where against a target of Rs1500 billion bids were made for about Rs880 billion, leaving a gap of Rs620 billion. Supposedly, the buffer would be depleted by half. It is not clear whether it would be replenished, and if so it would be a constant source of additional borrowing and concomitant interest cost to the budget.

Third, such an arrangement runs counter to a number of provisions in the State Bank Act, 1956. Under Section-9B of the Act, the Monetary and Fiscal Policies Coordination Board headed by the finance minister is the forum that decides about the consistency of two policies. Sub-sections (c) and (e) deal with the limits on government credit from commercial banks and the central bank. Now, in the presence of such space available to the government under the law, it is difficult to find a justification for such stringent and cost-ineffective ways on the government to meet its financing needs. The people should be taken into confidence if we have conceded to the IMF that these provisions would be scrapped and that the government would be reduced like an ordinary borrower in the banking system to meet its needs from the market.

Fourth, the above scenario is akin to ceding government authority to create money. The federal and provincial governments may soon face the risk of running out of money in the central bank, and face the possibility of their checks bouncing. Since fundamental issues of sovereignty for creating money are involved, it was imperative for a law to be presented in parliament before such far-reaching changes in the SBP law were acted upon.

In another development, a huge amount of short-term bills held by the SBP have been converted into long-term bonds. This has been done without publicly notifying the changes in the rules, which previously only allowed short-term bills for this purpose. The short-terms bills posed no re-financing risk because of SBP holding. The long-term bonds are very expensive. A more elaborate system of retirement would be required compared to retirement of TBs when foreign flows began to retire domestic debt.

The priority was given to SBP debt to be retired but with long-term bonds, it is not clear how this would be done. In fact, it should continue to be the case that bonds are retired irrespective of whether their maturities are due or not.

The writer is a former finance secretary. Email: waqarmkn@gmail.com