The federal government accumulated about Rs1.5 trillion worth of fresh domestic debt in the first eight months of this fiscal year.

The stock of debt swelled from Rs23.28tr in June 2020 to Rs24.78tr in February.

Whenever the government adopts an expansionary fiscal policy — meaning it spends more than its revenue collection to boost the economy and create jobs — it resorts to additional borrowing. And, domestic borrowing comes handy particularly from commercial banks.

But excessive government borrowing from banks crowds out the private sector. Depending upon the extent of this crowding out, the private sector’s contribution towards economic growth and job creation could be smaller than required. And, that frustrates the very objective of an expansionary fiscal policy. Just how badly the private sector is being crowded out can be gauged from the fact that its fresh net borrowing from banks remains a little over one-fourth of the government borrowing. Between July 1, 2020 and March 19, 2021, the private-sector credit offtake from banks totalled Rs382 billion only against that of Rs1.45tr by the federal government.

Honest and serious joint efforts can work wonders for the economy

Higher government spending facilitated by higher bank borrowing to enhance GDP growth creates demand-induced inflation via expansion in money supply. The yearly increase in national average consumer inflation stood at 9.1 per cent in March.

Over investment by banks in sovereign debt papers through which the government borrows money from banks has also increased banks’ reliance on these papers for profit-making. And, this has sent the advances-to-deposits ratio — an indicator of the soundness of the financial system to 49.4pc as of the end of February. This is an unsustainably low level for financing growth through the private sector, the main engine of economic growth, for mobilisation of savings and for the soundness of the financial system.

Recently, the government went for external borrowing through Eurobonds on very high returns — 6pc on five-year bonds and 7.375pc on 10-year bonds. Such high returns, offered to attract desperately needed foreign funds, can disturb the interest rate structure in the domestic economy. Besides, the rupee counterpart of foreign funds raised through such bonds — or even through foreign investment or external borrowing from international financial institutions or friendly states for that matter — increases money supply in the economy. That, in turn, weakens the local currency and produces inflation.

Downward exchange rate adjustments made by the SBP too independently create many problems

These are just a few examples of why the central bank — whose main job is to check inflation and ensure stability of the financial system — must be taken on board by the government.

On the other hand, when the central bank tries to contain inflation by hiking interest rates, the rate rise can choke GDP growth and can lead to increased unemployment. This can also push the cost of domestic debt servicing affecting the government’s ability to spend adequately on national defence and socio-economic development. That is why it seems sensible for a central bank — particularly the central bank of a developing country like Pakistan — to formulate monetary policy in active consultation with the government.

One of the reasons why the economy grew just 1.9pc in 2018-19, the first year of the PTI’s government, was that the SBP kept tightening interest rates at that time to check rising inflation.

Downward exchange rate adjustments made by the central bank too independently — in disregard to its impact on external debt servicing requirements — also create problems for a foreign debt–laden and foreign exchange–starved country like ours. The rupee cost of external debt servicing increased considerably due to the rupee depreciation in the past two years — by a whopping 32pc in 2018-19 and 4.75pc in 2019-20. It is a separate story though that the central bank had no other option but to let the rupee find its market value because in preceding years of the PML-N, the SBP had to keep the rupee overvalued through frequent interventions in the foreign exchange market on instructions from the then finance minister. And, we all know how brazenly he opposed a downward adjustment by the central bank towards the end of the PML-N government and forced the SBP to reverse the move after inducting a new central bank governor in the office.

Effective coordination between fiscal and monetary authorities in determining the broader exchange rate strategy is good for the economy. But leaving the operational framework in the exclusive domain of the central bank is a must.

So it is desirable for the federal government and the SBP to keep the Monetary and Fiscal Policies Coordination Board alive as it provides them with a statutory platform to reach consensus on certain crucial matters before making policies in their respective jurisdictions.

The draft legislation that seeks greater autonomy for the SBP has proposed abolition of the board. But SBP Governor Dr Reza Baqir recently hinted in a local TV talk show that he was not against the idea of fiscal and monetary policy coordination. Political parties in the opposition and even some leaders of the ruling PTI are already against abolishing the board.

Fiscal discipline obtained ideally prior to — and not so ideally in the initial phase of — inflation targeting makes it easier for the central bank to keep inflation within a certain range in the medium term. That is an important first for stabilising the economy and then putting it on a sustainable growth trajectory. And one practical way of ensuring fiscal discipline is to let the Monetary and Fiscal Policies Coordination Board continue to function. The only thing the government and the SBP will have to ensure is that the board remains an institutional platform for developing consensus on the best available options in fiscal and monetary policymaking — and not a government agency to dictate its terms to the SBP.

Honest and serious joint efforts of the government and the SBP can work wonders in addressing key issues of the economy. The most recent example is that of Roshan Digital Accounts for overseas Pakistanis that have significantly boosted remittances.

Published in Dawn, The Business and Finance Weekly, April 12th, 2021