Talal Wasif Qavi mentions a restriction
SBP Extending Credit To Government – The State Bank of Pakistan reportedly refuted the claims that it has extended Rs.239 billion credit to the government though clarifying that this was not fresh credit. SBP was constrained to clarify the matter in wake of a report of a think tank that pointed out that in an apparent deviation from the law the SBP has reportedly extended this credit to the coalition government in January-February to meet ballooning debt servicing requirements of the domestic commercial banks. Under the State Bank of Pakistan Act amended in 2022 on the demand of the IMF, government borrowing from the central bank is prohibited as Section 9C of the law exquisitely prohibits the central bank from extending any direct credits to or guarantee any obligations of the government or any government-owned entity or any other public entity. This contravention is supposedly considered quite dangerous in the existing circumstances whereby the parley between the government and the IMF have been deadlocked and this action may further complicate matters.
In this context experts point out that direct lending by the central banks to the government is mostly harmful whereas government borrowing from commercial banks is less harmful. Banking sector the world over acts as financial intermediary as they have the ability and wherewithal to cheaply raise deposits and lend them on high rates. For common people the utilising the facility offered by a financial intermediary ensures promoting savings while lending funds to investors and this cycles usefully aids to the overall financial system and adequately meets the monetary needs of the people. The lending process comes with incentives on both sides of the divide as the rate at which money is lent and at which depositors of savings are paid back fluctuate with the conditions of the market within the domain of deposit rates, lending rates and interest rates.
This situation changes when large entities such as government borrow from commercial banks because it raises the demand for credit without an increase in deposits but with lending rates going up. However, the increase in deposit rates will be accompanied by corresponding rise in the lending rates providing people with cash some additional incentives to increase deposits. It must be kept in view that in this case the financial intermediaries have some built-in mechanisms to promote savings besides making loans accessible and this is the safety valve and may prove beneficial. This process is widely acceptable and both the borrowing government and the commercial banks are provided with enough space to adjust their positions accordingly.
The situation in case of the government borrowing from the central bank radically disturbs the balance of the equation as it depresses the interest rate that would have resulted otherwise in causing hindrance to savings lowering investments as has happened with Pakistan before. It has been observed that the financial system became constrained in lending to the private sector though it was not necessarily high lending rates restricting investments but low savings rates and has become an additional reason for depressed savings scenario.
The government borrowing from the central bank is usually referred to as effective saving inhibitor and constitutes a serious drawback of this lending as it comes out of thin air instead of savings. The thin air implies printing of currency by the government causing inflationary impact of government borrowing from the central bank. It neglects the critical consideration that savings mobilisation should be the prime mover catering to the borrowing needs of economic agents including the government. Direct central bank credits should not be the prime movers but should always be available to banks through open market operations or other refinancing windows as supplemental mechanisms. This is the reason that there exists a strong negative link between the government borrowing from the central bank and depression of national savings though this point is often ignored by most financial commentators.
It is in this drawback that it was pointed out by the SBP that the government has borrowed from the central bank against the express demand of the IMF that impresses the folly of suppressing savings when such action takes place. However, the SBP clarification emphasised that the contents of the report about lending to the government contains data calculated on accrual basis which took into account accretion of interest over time and impact of exchange rate fluctuation in case of on-lending of Special Drawing Rights (SDR) Allocation, received by the government of Pakistan as a member of the IMF. Furthermore, gross amount of lending is netted-off against the government deposits with the SBP. It added that based on these reporting principles the increase of net SBP credit of Rs.239 billion to the government sector is attributable to constituent elements such as accrual of interest, impact of exchange rate revaluation and decrease in government deposits with SBP. The SBP categorically mentioned that it had not extended any fresh loan to the government since the promulgation of SBP Amendment Act 2022.TW
Talal Wasif Qavi is a barrister