How far the legislative autonomy has worked to enhance the effectiveness of the central bank in terms of the goals set out therein? There are three areas that would be of interest in this regard: government borrowing, policy rate and exchange rate. These are primarily the variables whose policies are formulated by the SBP.
As we had mentioned in the last article, Government's borrowing from the SBP is the most important concern of those who would like to see an independent central bank. During the programme period, the government agreed to a highly ambitious target of bringing down the outstanding debt owed to SBP from nearly Rs 2.7 trillion to Rs 1.4 trillion. Obviously, it was expected that this would continue until it was about Rs 1 trillion, which would be needed by SBP to undertake its open-market operations (OMOs).
This reform was undone no sooner than the programme ended. The stock of Government debt as on 30-6-2016 was Rs 1.4 trillion, which on 19-1-2018 has jumped to Rs 3.2 trillion, which is more than doubled within about 18 months. In fact, it is confounding to see that Rs 900 billion have been borrowed from SBP since July 2017, and more than half (Rs 466 billions) of this amount for the purpose of retiring the commercial banks debt. It is ominous that Government debt with commercial banks is deleveraged since that would mean a complete negation of the intended reform. Such an unbounded Government borrowing is not merely a reversal of a reform, but the consequent rise in the debt stock would make it impossible to aim for its retirement in the future.
An analysis of the Government debt market is quite revealing as to what is happening. The government paper has suffered a loss of appetite from the investors. In the last four auctions, bids for only three months paper were received. Banks were not interested in bidding for six months and twelve months. Indeed, six months bids were missing in the last four auctions while twelve months bids were missing for more than eight auctions. With primary dealers not participating and offering the desired amounts, SBP is picking the tab - without protesting, it seems. This also has implications for adversely affecting the maturity structure of the government debt, as it has tilted heavily in short-term maturities, posing dangers of frequent refinancing needs. We would reflect in a while what expectations were formed by banks.
The situation also points to a violation of the law. Section-9C(1) of the SBP Act, 1956 requires quarterly zero borrowing for the Government, which is obviously violated. The retirement of the outstanding debt required under Section-9C(2) is out of question in 12 years (completing in 2023) as the time limit was set when the debt was at Rs 1.4 trillion. With the debt stock at Rs 3.2 trillion, retiring it in the next five years is near impossibility.
Regarding the policy rate, the MPC is now a new institutional arrangement and its efficacy would be tested with time. So far it has functioned in a placid state where the policy rate was unchanged during the time it came into being. However, the MPC does not seem to be bothered until November last year about the phenomenal increase in government borrowing (which even at that time had risen by more than a trillion since June 2016). More importantly, they failed to see then and even in January the disruption in government debt market where except for three months paper banks had stopped lending to the Government. Clearly, the market was not ready to lend to the government at the prevailing rates. A rate increase of 25 bps in January has failed to break the logjam in the market. The auction held on 31st January again did not attract bids in six and twelve months papers, clearly signaling that MPC's rate increase was considered by the market insufficient.
The government had a target of Rs 900 billion (with Rs 57 billion for new borrowing and the rest for re-rolling). Against a bid amount of Rs 1.8 trillion (all in three months), the government picked up Rs 1.2 trillion. This means fresh borrowings were Rs 357 billion, all in the shortest tenor with the cut-off yield rising by only 21 bps.
It is also remarkable to notice that during the period SBP has started lending to the government, banks have found it far more lucrative to lend to the private sector. In FY17, the highest ever credit flow of Rs 748 billion went to the private sector. This fiscal year until 19 January, credit to private sector amounted to Rs 216 billion. Given the robust economic environment, the demand for credit in the private sector is rising and its quality is also good. Under the circumstances, the MPC has to do catching up.
On the exchange rate side, things are even more challenging. In FY17, nearly Rs 450 billion, or around $4.5 billion, of net foreign assets (NFA) were lost, in sharp contrast to the regular build-up of NFA during the programme period FY2013-16. In this fiscal year, until 19 January, loss of NFA is Rs 254 billion (or about $2.5 billion). The reserves loss in FY17 was about $4 billion while $2 billion have so far been lost in FY18. Note also, during FY18, we have already borrowed about $3 billion for BoP support, implying that we have used these also for current account financing, unlike using them to build reserves (adjustor). To put it more simply. we have used up $9 billion to support the rupee.
Before we explain the underlying economics, let us remind ourselves that the SBP (Amendment) Act, 2015, made the following provision in the revised Section-9A(1)(b) dealing with the functions of the Board of Directors of SBP: oversee foreign exchange reserve management and approve strategic investment and risk policy. Accordingly, the SBP is fully empowered to manage country's reserves, particularly in maintaining exchange rate stability within reasonable bounds.
We have been writing with considerable pain that there is no sanctity of the exchange rate. In economics, it is just another price (for foreign exchange) which cannot be held at an artificial level for too long. Undoubtedly, every central bank would attempt to preserve stability of the exchange rate. However, the ability of any central bank to meaningfully play this role depends on the level of reserves it is holding. In the three years of the programme, we succeeded in maintaining exchange rate stability as there was a very high level of liquidity in the backdrop of massive decline in the oil prices. Therefore, we had plenty of space to maintain stability and keep meeting condition of rising build-up of reserves under the programme. That liberty ended soon after the programme as we decided to undo all that we had achieved under the programme. Consequently, we lost the support of our development partners as they stopped providing concessional support for balance of payments. Pakistan has nowhere to go for meeting its financing requirements. Use of reserves instead, particularly those borrowed at a significant price, is highly untenable and does not meet the requirements of prudential economic management. (To be concluded)
(The writer is former finance secretary) [email protected]