There is no denying that the main implication of fiscal imbalance for monetary policy is excessive borrowings from the banking system, including the SBP. According to a SBP report, during 1st July-29th March, FY13, government borrowed Rs 853 billion (on cash basis) from the banking system for budgetary support compared with Rs 925 billion in the corresponding period of last year and against a full-year estimate of Rs 484 billion for FY13.
The high level of these borrowings has kept an upward pressure on the system's liquidity and thus market interest rates and is restraining growth in the private sector credit. As pointed out in the report, the SBP can provide liquidity through short term Open Market Operations (OMOs), which has been the case during most of FY13, as long as inflation expectations remain manageable. "However, even if inflation continues to remain within the announced target, this approach cannot be sustained for longer periods since it does not address the source of the problem. The source of the problem is untargeted subsidies and the absence of meaningful tax reforms to increase the tax base. The implications are high borrowings and a rising debt level, which have considerably increased debt servicing expenditures," according to the report.
The government is required to pay full attention to the menace of untargeted subsidies. It is also required to expand tax base through a set of tax reform without any further loss of time.