There is no stoppage to fiscal deficit growth. FBR collection by June end is likely to be less than last year. The next year Rs5.5 trillion target - growth of around 40 percent, is near to impossible, and deficit financing budgeted at Rs3.1 trillion (expected to grow by Rs500-1,000 bn due to slippage in deficit) will become unmanageable, if SBP borrowing conduit, as per IMF condition, is to be stopped. The asset declaration scheme is not yielding any returns in term of revenues or documenting assets.
In the absence of foreign flows - budgeted at Rs1.9 trillion on net basis, the government has to either continue with SBP borrowing or exit the IMF deal. The only other way is to get the currency back into the banking system. The cash holdings at homes, bank lockers, offices or other places are growing at a brisk pace, which is shrinking the bank deposits relative to the size of the economy.
The cash holdings stand at Rs5.1 trillion currently and it is 13.3 percent of GDP. That is too high a number. The toll was Rs1.9 trillion or 8.7 percent of GDP back in FY13. The growth in government development spending, especially by provinces, after the 18th amendment, is closely linked to abnormal growth in cash economy at a time when the world is shifting to digital economy.
The other problem is that with a growing economic pie, tax evaders started dealing in cash, especially after the distinction of filers and non-filers. Cash business transactions increased, and till date they are climbing.
There are kickbacks in government procurement and development projects. Higher the development budget, higher the bribes and these are mostly dealt in cash or unregistered prize bonds - as well as cash. One can carry tens of millions of cash in pockets without being noticed as one pile of 100 prize bonds of Rs40,000 worth Rs0.4 million and one can carry 5-7 piles in normal clothing. This can be used in bribes and other illegal transactions.
The bond issues almost tripled during 2013-18. That conduit is to be stopped now as 40,000 bonds (amounting to Rs265bn) are now going to be registered and fresh issuance is going to be banned, same is to be followed in 25,000 (amounting to Rs160bn) and 15,000 (amounting to Rs177) denomination bonds.
Nonetheless, prize bonds are part of the fiscal deficit financing and government pays return on it. The financing of fiscal deficit is to deal with bringing cash in local currency and conversion of foreign currency holding back into the system. If CIC is to be brought to FY13 levels, in terms of GDP, Rs1.8 trillion can be fetched back to the banking system.
The banking deposits currently stand at Rs13.5 trillion according to SBP monthly deposits data, while from the weekly M2 profile, the toll is at Rs11.6 trillion. The M2 definition is based on the overall monetary assets and is a better indicator.
Rs1.8 trillion can increase the bank deposits by 15 percent and that incremental liquidity can be used not only to finance government deficit but also for private credit expansion. The budgetary target of financing is Rs3.1 trillion - Rs1.8 trillion foreign and Rs1.3 trillion (within it Rs819 billion non-banking finance), and from banking system, the financing is projected at mere Rs339 billion (10.8% of total).
Any slippage in fiscal deficit is to be financed by banking system, and any less financing from foreign or non-banking will go on to banking. This will put pressure on market rates, if central bank financing is not an option.
The fall in currency rates, increases the rupee counterpart of foreign financing and will help in easing the domestic debt burden. However, rise in domestic interest rates, to curb inflation due to currency depreciation, increases the domestic debt servicing, and due to sheer size of domestic debt, the cost of interest rate increases more than it offsets the gains. A better way to get out the rut of fiscal financing trap is to bring back the currency in the system. The excess liquidity may help lower market rates, and create space for credit to productive private sector.
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