Hefty govt expenditure blamed for inflation

State Bank of Pakistan threatens to stop making payments to provinces should they go above their overdraft limits.

KARACHI: The State Bank of Pakistan (SBP) has blamed the government borrowing from the central bank for persistent inflation and threatened to stop making payments to provinces should they go above their overdraft limits with the bank.

Announcing the monetary policy on Monday, the SBP said that “the entire responsibility of tackling macroeconomic problems has been unfairly placed on monetary policy only” and offered evidence that inflation is persisting due to uncontrolled government borrowing.

Explaining that “high inflation, at a fundamental level, persists because of money creation in excess of productive activity in the economy”, the central bank then pointed out that out of the Rs308 billion increase in reserve money up to November 19, Rs266 billion was due to government borrowing from the bank. It then bluntly added that “this fiscal expansion is the fundamental source of high inflation in Pakistan over the last year.”

The SBP pressurised the government to implement its fiscal restructuring reforms that include broadening the tax net, eliminating power subsidies and finishing the legislation of the amended SBP Act. However, the central bank said that even after the implementation of such measures, it will take a while for an impact to be visible and for growth to resume.

It added that the government needed to manage private sector expectations by demonstrating its commitment to containing the monetisation of its deficits and to implementing fiscal reforms.

The SBP then pointed out that “the recent rejection of the two Pakistan Investment Bonds auctions in the first quarter of fiscal year 2011 and the acceptance of Rs50 billion instead of the Rs90 billion offered by banks in the treasury bill auction held on November 16 is apparently inconsistent with the [government’s] stated intentions”.

Offering more proof to reinforce its argument, the SBP said that the ratio of net domestic assets (a measure of government borrowing) to net foreign assets on the SBP balance sheet has shown a strong correlation with CPI inflation and does not bode well for either the current or the next fiscal year in terms of double-digit inflation.

Published in The Express Tribune, November 30^th, 2010.