Inflation is expected to rise in coming days, necessitating a further increase in interest rates.

Finance Minister Asad Umar has presented a revised version of the federal budget for 2018-19 that aims fiscal tightening. But the government’s decision to increase gas prices and let non-filers of income tax returns buy cars and properties are two key moves that will fuel inflation — the first through a ripple effect on the entire economy and the second by causing an expansion in the currency in circulation.

Another decision that can expand the currency in circulation is the increase in tax on banking transactions (other than cash) of non-tax filers from 0.4 per cent to 0.6pc.

The ongoing pressure on the rupee amidst depleting foreign exchange reserves can also add to inflationary pressures. But to counter that, the government has levied regulatory duties and imposed higher customs duties on a range of import items.

Apart from seeking donations, the government can also launch dedicated bonds to raise money from resident and non-resident Pakistanis for the construction of dams

The purpose behind the budget revision is to keep the fiscal deficit to 5.1pc of GDP, down from 6.6pc last year. Had the original budget presented by the PML-N government not been revised, the deficit could have reached 7.2pc, Mr Umar said.

But the Pakistan Tehreek-i-Insaf (PTI) government will have to walk a tightrope to materialise this goal. The US-China trade war is raging, currencies in the emerging economies are in trouble, a stronger dollar is adding to the cost of our external debt servicing and foreign funds are flowing out of our stock market on a net basis. This is happening at a time when foreign exchange reserves are barely enough to cover two months of imports, the current account deficit is high and the overall balance of payments is out of shape.

Prime Minister Imran Khan’s visit to Saudi Arabia and the United Arab Emirates has raised hopes for some sort of immediate financial support for our external account, but a lot depends on the quantum and nature of that support.

The recent visit to Islamabad by British Home Secretary Sajid Javid has rekindled hopes for a faster retrieval of our untaxed or undeclared assets parked in the United Kingdom. But even an accelerated process of recovery will take years to haul in a few billions of dollars.

The biggest challenge is to reduce the country’s reliance on external borrowing. But it remains unclear when exactly our faltering balance of payments will be shaped up and how — with help from friendly countries, borrowing from the International Monetary Fund (IMF) and other international financial institutions, recovery of “stolen assets abroad” and “proceeds of financial corruption” floating in the parallel economy?

Pakistan’s total external debt and liabilities reached $95 billion in 2017-18 from $83.4bn a year before. For a $313bn economy, $95bn means more than 30pc of GDP. How sustainable it is under the current geopolitical situation and amidst a growing cost of debt servicing remains a key question.

In 2017-18, about $2.29bn was paid in interest and $5.18bn went in the repayment of the principal amount. So external debt servicing consumed $7.48bn — or one-third of total exports.

The need for external borrowing arises for a lot of reasons. One primary reason is the inability of the government to fill the gap between its income and expenses with domestic borrowing.

There are several sources and tapping each one efficiently can reduce the need for external financing. But here again the problem is that the stock of domestic borrowing itself has already reached a point where further accumulation carries some economic and market risks.

At the end of 2017-18, the stock of domestic debt and liabilities stood at Rs17 trillion ie close to $140bn (converted at the exchange rate prevailing at that time) or roughly 45pc of GDP.

So regardless of political and social costs that we have to pay for external borrowing, it cannot be reduced substantially unless we increase domestic borrowing, grow revenues or reduce expenses.

Since the PTI government is committed to reducing the debt burden, it wants to opt for minimum external borrowing. It wants to increase revenues and reduce expenses. But that takes time particularly when you have large targets in both areas. Letting domestic debt grow, meanwhile, makes sense.

Hence, the recent interest rate tightening should be seen as a product of economic necessity. Interest rate increases in the present scenario can also help stabilise the rupee a bit and check inflationary pressures.

In the financial market, people are talking about another policy rate hike. In mid-July, the central bank raised the rate by 100 basis points to 7.5pc. Many of them anticipate another 100bps increase now.

After monetary tightening in mid-July, returns on National Savings Schemes (NSS) have gone up, making them more lucrative for people. In 2017-18, fresh investment in NSS totalled around Rs203bn. The figure can go higher this year. Money invested in NSS forms part of domestic debt.

The bulk of domestic debt, however, rests in government borrowing from banks via treasury bills and bonds.

It is discouraging to see that despite immediate needs, policymakers are not trying to diversify the base of domestic debt. If the proposed dollar-denominated diaspora bonds are not being launched considering the incremental cost of external debt servicing, the government can issue special bonds for overseas Pakistanis. They can be asked to invest in those bonds and get returns in rupees in local bank accounts.

Apart from seeking donations for the construction of dams, the government can also launch dedicated dam bonds for both resident and non-resident citizens and pay returns in rupees.

Published in Dawn, The Business and Finance Weekly, September 24th, 2018