Dominant borrower

Beneath all the commentary on the details and implications of the recently concluded talks with the IMF, an important analysis has gone largely unremarked, save for one insightful article.

It grows out of an analysis presented in a special section of the last quarterly report put out by the State Bank of Pakistan (SBP). Buried in Chapter 3 of the report is a special section innocuously titled ‘Macroeconomic Dynamics with a Dominant Borrower’.

The section asks this question: “With an insatiable government appetite for credit, how does the central bank contain the quantum of inflationary finance and yet ensure the private sector is able to secure adequate credit from commercial banks?”

Translation: what do you do when the government takes all the money in the banking system and digests it as part of its day-to-day spending?

The question is important because even a first-year student of economics can tell you that an economy can only grow and create jobs and alleviate poverty and arrange investment for future growth if funds are available for investors to borrow and invest.

But when the government enters the market with an “insatiable appetite” and takes all the money, leaving nothing behind for anyone else, and spends it all on paying for things like salaries of government servants and retiring the circular debt — effectively paying for yesterday’s consumption — then of course the banks will not be in a position to lend to anyone else and provide for future investment.

The authors of the section lay out the scenario in a short four-point summary of the status quo. “The policy outcome so far is not heartening: (1) despite a 450 bps [basis points] cut in the discount rate over the past 20 months, net private-sector lending remains anaemic; (2) spreads in the banking system remain high; (3) SBP financing of the fiscal deficit has increased sharply since Q3-FY13; and (4) the balance sheets of commercial banks continue to skew in favour of government paper.”

Basically they’re telling us that a malign symbiosis has emerged. All the investible capital in our economy is being eaten up by government to pay its bills, and the banks are only too happy to oblige since lending to government carries little to no risk on the face of it.

So both government and banks are satisfied with the arrangement, which is suffocating the economy and its growth prospects.

None of the stakeholders involved have any incentive to break the relationship since they’re both getting everything they want out of it: for the banks, a steady and risk-free customer and for the government a ready avenue to avoid difficult choices like taxing key constituencies who have grown far too accustomed to making their fortunes outside the tax net.