ARTICLE: Pakistan's budgetary financing operations (federal and provincial) July-June 2019-20 were released on Wednesday - the day after the briefing on the data to the cabinet on 11 August 2020. Prime Minister Imran Khan appreciated the efforts of his economic team leaders (an appreciation that he has in recent weeks publicly extended to other cabinet colleagues at relevant fora); and accounted for his claim in his Independence Day message that "things are now improving on the economic front." The question is if his optimism is misplaced?
The consolidated federal and provincial budget report for last year shows a marked rise in government's non-tax revenue - from the budgeted 894.4 billion rupees to 1.296 trillion rupees in budget documents and 1.524 trillion rupees in the recently released consolidated budget operations data. This improvement in revenue collection is entirely attributable to an increase in State Bank of Pakistan (SBP) profits - from the budgeted 406 billion rupees to 785 billion rupees in the revised estimates as per the budget documents and a little under a trillion rupees - 935,519 billion rupees - as per the consolidated statement. In percentage terms that his economic team leaders resort to when actual numbers remain poor (for example export growth in percentage terms versus in actual dollars) SBP profits in the revised estimates as per the budgeted projection rose by 130 percent; and again by 19 percent in the consolidated budget operations data in comparison to the revised estimates made in the budget presented to parliament a mere two months ago.
To understand this dramatic rise it maybe prudent to quote a British source as members of the incumbent cabinet like their predecessors find Western sources much more credible. Members of the UK's Parliamentary Committee on Public Enterprises inquired why the central bank made lower profits in one year than in the previous year. The response was as follows: "central banks can make profits just by making book entries, those book entries invariably lead to an increase in money supply and through it an increase in inflation rate and therefore good central banks which are expected to keep inflation at a low and stable level do not target for profits but allow profits to arise in their normal monetary policy operations. By the same token, if a central bank has increased its profit levels through its domestic operations, it means that the particular central bank has caused inflation in the economy by expanding its asset base and it is not a good barometer of evaluating the performance of a central bank."
It was further emphasized to the committee members that if a central bank wants to make more profits, all it has to do is to buy more Treasury bills, lend more to banks or simply buy assets in the market which will generate incomes. But a central bank that does precisely that does so at the expense of creating higher inflation in the economy.
Pakistani governments have traditionally relied heavily on borrowing from the SBP barring those years when the country was on an International Monetary Fund (IMF) programme as the Fund's standard policy matrix includes zero borrowing from the central bank. Thus our government did not borrow from the SBP while it was on a three-year Stand-By Arrangement (2008), three-year Extended Fund Facility (EFF) programme (2013) and, at present, in the thirtynine-month EFF programme (2019). Ironically, the incumbent government with its current economic team leaders - Dr Hafeez Sheikh, Advisor to the Prime Minister on Finance and Dr Reza Baqir, Governor SBP - used this source just before going on the Fund programme.
The conclusion that may be drawn is that while the SBP insisted on a prohibitively high discount rate, 13.25 percent, that choked off all economic activity (and this is pre-Corona) it was fuelling inflation through its profits. A never quoted statistic by the team leaders is last year's inflation rate of over 11 percent against 6.3 percent in 2018-19.
Professor Martin Schmalz, Associate Professor of Finance, Saïd Business School, University of Oxford in a recent paper with two other colleagues presented empirical evidence that led him to conclude that: "we document that central banks are significantly more likely to report slightly positive profits than slightly negative profits, especially amid greater political pressure, the public's receptiveness to more extreme political views, and when governors are reappointable. Profit concerns are absent when no such factors are present." Disturbingly, two of these conditions apply with respect to Pakistan today. There must be considerable political pressure to show higher non-tax revenue with higher SBP profits a relatively easy option.
The IMF, the guiding entity in terms of policy decisions in Pakistan today, in its working paper 12/16 argues that "in developing countries, central bank financing to the government may be warranted in the short run. In these countries, government revenues exhibit seasonal fluctuations and capital markets are shallow, thus making the case for allowing central bank financing in the short run-via overdrafts or through advances-to smooth out seasonal revenue fluctuations.....The design of a good institutional arrangement for government borrowing from the central bank is not independent of the country's exchange rate regime. While banning central bank lending to the government is as critical as an anti-inflation policy stance, economies with conventional pegs and intermediate exchange rate regimes (exchange rate bands) should be even more compelled to endorse this principle. Exchange rate targeting countries are particularly vulnerable to a large financing of fiscal deficits, as the increasing money supply can drain central bank international reserves, which, eventually, may lead to a costly Krugman-type balance of payment crisis."
Lower revenue in the current year is being attributed entirely to the Coronavirus however the unrealistic 5.5 trillion rupee target agreed on 12 May 2019 by the then newly inducted economic team leaders with the IMF as well as the choking off of economic activity due to the contractionary monetary policy during 2019-20 were disturbingly not raised as serious issues during the recent cabinet meeting.
The reason behind the defeat of the PML-N in the 2018 polls is partly attributed to the Panama case, partly to lack of support from powerful institutions however it is worth noting that when Nawaz Sharif was the Prime Minister he was persistently warned by senior members of his own party that Ishaq Dar's flawed policies would lead to electoral defeat in 2018 elections - a warning that he did not heed.
It is hoped that Prime Minister Imran Khan does not make the same mistake and he needs reminding that for the chief executive to say all is well and appreciate efforts of his economic team is unlikely to convince the public that this is indeed so.
(This is the first of a two part series of articles on the consolidated federal and provincial budgetary operations)
Copyright Business Recorder, 2020
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