Banks in Pakistan make most of their interest earnings through investments in treasury bills and bonds. What keeps this trend stretched year after year is that the government always needs to borrow from banks as its total yearly revenues fall short of meeting its total expenses.

Banks never meet the private sector’s borrowing needs. Incessant, excessive government borrowings from banks “crowd out” the private sector. What can be done to reverse this trend? Well, the government must cut its borrowings from banks in the first place. But to make this happen, the government must strive to match its revenue and expenses as much as possible. That is what some governments do and that is what some conveniently ignore.

Constitutional barriers regarding debt accumulation are also ignored, which gives any government a free hand to borrow from banks as much as it wants. When the country is under an International Monetary Fund (IMF) programme, the Fund highlights this problem.

In the recent past, the IMF made it mandatory for Pakistani governments to stop borrowing from its central bank, the State Bank of Pakistan. It also required the government to gradually retire the central bank’s borrowing instead of making fresh borrowing. Since the government borrowing from the central bank is more inflationary in nature than its borrowing from commercial banks, the purpose was to help rein in inflation.

In the first half of the current fiscal year, the private sector’s net borrowing from banks plunged to minus Rs8bn from Rs408bn

In FY22, ending in June 2022, the government retired Rs191bn of the central bank’s borrowing, but in FY23, it again borrowed about Rs109bn from the SBP. The IMF objected to it and again emphasised the need to retire old debts of the SBP instead of borrowing from it.

The government started doing this once again. Within six-and-a-half months of this fiscal year (between July 1, 2023, and January 13, 2024), the government has retired more than a trillion rupees of old debts of the SBP — Rs1.045 trillion to be specific.

But how did the government do this? Well, it simply borrowed money from commercial banks. That is why the government sector’s net borrowing from commercial banks in six and a half months of this fiscal year swelled to about Rs3.81tr from about Rs1.31 billion in the same period of last year.

Looking at it from the bank’s perspective, when banks had a window open for almost tripling their lending to the government with no fears of default and much lesser lending cost than the private sector, it was “natural” for them to look towards the private sector. They did exactly this.

The private sector’s net borrowing from banks plunged to minus Rs8bn (between July 1, 2023, and January 13, 2024). In the comparable period of the last fiscal year, the private sector’s bank borrowing was Rs408bn.

One important thing to keep in mind is that the central bank itself enables banks to lend excessively to the government: Whenever the interbank market has insufficient liquidity, the SBP simply injects lots of funds into the market ahead of auctions of treasury bills and bonds.

That makes it possible for the government to meet its periodical borrowing targets —or remain close to them. Unless this practice is made more difficult and conditional, banks would never make any serious effort to lend liberally to the private sector and the government will make no serious effort to explore as many ways as possible for tapping all sources of non-bank borrowing.

The recent move to sell government bonds through the Pakistan Stock Exchange (PSX) is appreciable. It will surely help the government gradually increase its non-bank borrowing and rely less on bank borrowing.

But since the government remains confident that banks are always willing to invest in T-bills and bonds — and the SBP is always willing to create liquidity into the banking system ahead of auctions of these bills and bonds — it will not make a serious effort to meet its non-bank borrowing targets. Only last week, the government missed its target of selling Sukuk at the Pakistan Stock Exchange, and it will continue to do so.

How Pakistan’s private sector suffers from insufficient bank credit is an open secret. We all know that in the absence of bank credit, large companies often consume their retained savings just to remain afloat, cut production or move away from their main line of enterprise and raise their stakes in least-documented, higher profit-yielding businesses.

Many small and medium enterprises turn to borrowing from the informal credit market — often at much higher-than-normal interest rates and explore more innovative ways of staying in or moving towards undocumented or least documented business enterprises.

In both cases, the economy suffers in that the size of the grey economy does not shrink — and, at times, expands — but the potential of tax revenue collection is never fully realised. That, in turn, keeps intact the government sector’s need to borrow more from commercial banks and further crowds out the private sector.

With the general elections due on February 8, there is not much time left for correcting entrenched vicious trends and cycles. Nor is the caretaker government the ideal collective to do this. Only the incoming elected parliament and the government can be expected to address such critical, structural issues of the economy.

However, the pre-poll environment does not indicate that we will have a strong parliament and a strong political government in place. How a possibly weak parliament and possibly weak elected government will take up this and similar economic issues — and how our powerful establishment will intervene to make matters good or worse cannot be predicted now.

But one thing is clear. The private sector of Pakistan (or whatever of it is left after ever-growing control of the powerful establishment over factors of production) cannot be kept starving for bank credit forever.

Published in Dawn, The Business and Finance Weekly, January 29th, 2024