In a little more than 10 months of this fiscal year, between July 1, 2022, and May 5 2023, the federal government’s borrowings from banks more than doubled to Rs2.97 trillion from Rs1.412tr a year ago.

This indicates that the government’s revenues are falling too short of meeting soaring current expenses. But the government’s expenses are not growing rapidly because it is pursuing too many or too large development plans, nor because the national security and defence are devouring national resources ravenously.

The government’s expenses have increased dramatically because it requires unprecedently large sums of money to service domestic and foreign debts. In nine months of this fiscal year, between July 2022 and March 2023, domestic and foreign debt servicing ate up Rs3.582tr, according to the Ministry of Finance. Against this defence spending claimed Rs1tr and the federal government’s share in development financing was a mere Rs293 billion.

It does not require a genius to understand that in the next fiscal year, this trend will continue. Debt servicing requirements will be even larger due to this year’s excessive domestic borrowing. And additional domestic debt servicing will be too large to nullify the reduced additional foreign debt servicing requirements of the next year due to reduced inflows of foreign debts this year.

Future federal governments will have to borrow excessively from banks to continue to service ever-growing stocks of domestic debts, necessitating even greater borrowings year after year

Out of the Rs3.582tr spent on overall debt servicing in July-March FY23, domestic debt servicing alone claimed about Rs3.107tr. Only about Rs478bn was spent on foreign debt servicing. Domestic debt servicing at this level equals 55.3 per cent of Pakistan’s total tax revenue.

Forget for a moment about the danger of Pakistan being caught in a foreign debt trap. That may or may not happen in the near future. Depends. But let’s accept the fact that we are already in a domestic debt trap.

Future federal governments, too, will have to borrow excessively from banks to continue to service ever-growing stocks of domestic debts, necessitating even greater borrowings year after year for the same purpose.

Banks, meanwhile, will continue to earn easy money by investing more and more in government treasury bills and bonds, catering less and less to the financing needs of the private sector.

Between July 1, 2022, and May 5, 2023, banks’ net lending to the private sector tanked to Rs129.6bn or one-tenth of Rs1.296tr recorded during the year-ago period. The economic decline is admittedly one of the reasons for it. But another reason is excessive government bank borrowing crowds out the private sector in Pakistan.

The private sector, whose financing needs are never fully met by banks, relies not only on informal borrowings from traditional and now digital loan sharks but also finds expansion of the undocumented economy in its interest.

On the one hand, continuous expansion in the undocumented economy discourages new entrepreneurs from exploring their export potential. And on the other hand, even existing export-oriented businesses find it easier to grow increasingly through enhanced domestic revenues rather than export revenues.

This form of export disincentivisation, coupled with numerous others, keeps our export growth low and becomes a reason for greater trade deficit. The government of the day often addresses the trade deficit problem by containing imports rather than doubling up efforts to boost exports.

As a result, export-oriented industries suffer more — due to the low availability or skyrocketing prices of imported raw materials. Consequently, exports start falling or become stagnant. In one particular year, the incumbent government presents the slashing of the trade deficit (chiefly through import restrictions) as a result of its farsighted policy.

But in the following years, that bubble bursts: imports start growing again not only to meet the pent-up demand of export industries but also because of the expansion in the undocumented economy. And exports, even when growing, fail to catch up with renewed growth in imports.

That obviously creates a shortage of foreign exchange and necessitates additional external borrowings. Pakistan is bound to see that happen in the next fiscal year after witnessing the above-explained kind of trade-deficit reduction this year.

The above discussion sheds light on a few aspects of our external economy. But it is not just the fundamentals of our external economy that affect exchange rates decisively. In Pakistan, as in most other developing politically turbulent countries, even momentary changes in perception about the local currency — and actions of currency speculators — play an important role in swinging the exchange rates one way or the other.

We should remember this point in our discussions on the post-May-9 dramatic decline in the rupee’s value and its equally dramatic resurgence. On May 9, the rupee finished its daily trading in the interbank market at 284.84 per US dollar. But within two days after Imran Khan’s arrest and the unfortunate events of violence and mayhem that followed, the local currency lost about 5pc of its value. On May 11, it sank to 298.93 to the greenback.

However, on May 12, the rupee made an equally dramatic comeback. It regained its two days’ losses in a single session and closed at 285 to a dollar. The market’s nervousness following May 9-10 unfortunate events triggered the rupee’s fall.

So, when the state reacted strongly to May 9-10 events promising “overwhelming actions” against those involved in violence and mayhem, that nervousness subsided, and the rupee’s position resettled.

Forex-starved State Bank of Pakistan watched from the sidelines as the rupee sank. But it played a role in the local currency’s resurgence. At least two of the five major commercial banks were seen pumping dollars into the interbank market on May 12, reportedly on behalf of the central bank.

Published in Dawn, The Business and Finance Weekly, May 22nd, 2023