MONEY WEEK: decline in corporate borrowings contributes to monetary contraction

Although it is normal to observe decline in corporate borrowings in the beginning of the financial year, it is unusually high this time around. Corporate sector retired about Rs 28 billion during the week between 1st August and 8th August accelerating overall retirement of credit to banks to Rs 79.5 billion during the first five weeks of the year which was Rs 35 billion higher than the amount retired in the corresponding period last year.
In the meanwhile, Government sector borrowing rose by another Rs 21.4 billion during the week ended on 8th August with its overall borrowing surging to over Rs 156 billion during the first five weeks of the year. Read with a build-up of other liabilities of about Rs 113 billion under Other Items (Net) of the banking system, the foregoing developments meant a net decline of Rs 36 billion in the NDA of the banking system during the year so far. The contraction impact originating from NDA of the banking system was further strengthened by a heavy draw-down of the NFA of the banking system (down Rs 39.5 billion) so that incremental money supply during the year to August 08, 2009 dropped by Rs 75.5 billion or about 1.5 percent.
Constituent wise, deposit money decreased by over Rs 46 billion during the week and by Rs 130 billion during the year so far while currency in circulation increased by Rs 34.5 billion during the week and by over Rs 54 billion during the year to August 08. The main reason for a massive decline in deposit money could be traced to decline in borrowing by the corporate sector (down about Rs 79.5 billion including private sector- down Rs 67 billion and PSEs- down abut Rs 12.5 billion) and a draw-down of net foreign assets (NFA) of the banking system amounting to Rs 39.5 billion during the year so far. Both require surrender of liquid funds including funds kept in bank accounts to the banking system.
Increase in currency in circulation may be ascribed to government''s budgetary borrowing from the central bank (up Rs 103 billion) aggravated by a less than satisfactory figure of budgetary borrowing of Rs 54.5 billion from scheduled banks during the period.
In the preceding week, the ratio of budgetary borrowing from the central bank and scheduled banks in percentage terms worked out to 55.5 and 44.5. This week, the ratio tilted more towards the central bank (rising to about 65.5 percent) than the scheduled banks (sliding to about 34.5 percent). A greater recourse to borrowing from the former to fill the revenue gap, it may be recalled, gives rise to increase in currency in circulation- a major component of primary or seed money.
It is for this reason that it is argued that budgetary borrowing from the central bank if continued is fraught with concerns ranging from flaring of inflation in the economy to lending instability to the domestic currency. But as long as army operation against terrorist forces in FATA persists, we have to live with deficit financing larger than ordinarily perceived and possibly also to a larger recourse to the central bank to finance it at least initially.
A word about the depleting net foreign assets (NFA) of the banking system: The depletion stood at Rs 33 billion on 25th July, 2009, rose to Rs 37 billion on 1stAugust and further to Rs 39.5 billion on 8th August 2009. The State Bank has not updated its data of liquid foreign exchange reserves. Last week, liquid foreign exchange reserves were reported to have declined to $11.7 billion from $11.8 billion on 25th July, 2009.
Despite reported receipt of augmented assistance from IMF, In the meantime, the rupee which had recovered to Rs 82.58 and Rs 82.63 per US dollar for buying and selling purposes as at the close of business on 13th August, 2009 slipped again in the following days with the parity deteriorating to Rs 82.90 and Rs 82.95 per US dollar respectively on Friday the 21st August 2009.
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