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Sunday March 03, 2024

More money, more problems

December 10, 2023

The government continues to run its fiscal affairs with an increasing reliance on debt to fund its expenditures. The reliance on debt to fund fiscal operations has never been greater, and it is only getting worse.

Economic growth which is largely driven by consumption, fuelled by imports, continues to remain constrained as the country scrambles to maintain, and arrange foreign currency liquidity. In the absence of imports driving consumption, economic growth is expected to remain muted – and as that remains low, tax collections associated with growth are also expected to remain low in inflation-adjusted terms. In such a scenario, the fiscal deficit may continue to increase, and will inadvertently be funded by accumulation of more debt.

A foreign currency dealer counts US dollars at a shop in Karachi, Pakistan, May 19, 2022. — AFP
A foreign currency dealer counts US dollars at a shop in Karachi, Pakistan, May 19, 2022. — AFP

Broad money is effectively money that exists in the system and largely comprises currency in circulation, and various deposits that exist with the central bank, and commercial banks. The government continues to rely heavily on borrowing to fund its fiscal operations, which inadvertently leads to growth in broad money, as more money is created by the central bank to meet the insatiable requirements of the government.

A review of broad money (M2) numbers shows that government borrowings associated with budgetary support reached an all-time high, at 78 percent of broad money. Such borrowings relative to broad money have been inching up over the last twelve months and, considering how things are panning out, may only increase further.

Borrowings associated with budgetary support have hovered in the range of 65 percent of broad money over the last five years. It has only been in the last 12 months that, as a percentage of broad money, it has started to increase. This demonstrates the increased reliance of the government on domestic debt, and printing money to fund its fiscal operations. Although the earlier practice of directly borrowing from the central bank has stopped, it has been replaced by Open Market Operations, in which the government eventually borrows money from banks at a relatively high interest rate.

But what happens when money continues to be created by the central bank? It means that there is more money in the system, circulating in the economy, and that same money is now chasing a finite number of goods, or services, or even foreign currency, to pay for imported goods and services. As there is more money chasing fewer goods and services, there is more demand for the same. As demand increases, and supply relatively stays unchanged, price levels increase, resulting in more inflation. This is precisely why inflation continues to increase unabated while in the rest of the region and the world, it continues to slow down. As more money exists in the economy, and as that money continues to fund ever-increasing government deficits, there will be more problems.

If there ever is an intent to reduce inflation, and to actually meet elusive inflation targets, the first order of business should be to reduce fiscal deficits, and that would imply either increasing revenue or rationalizing expenditures. Increasing revenue by taxing a narrow tax base is only going to make things worse, further eroding household incomes and disincentivizing operations in the formal economy.

Expanding the tax net to segments of the economy that remain largely untaxed remains crucial, and has been the case for more than five decades at this point. Any further delays on this front will continue to make matters worse, further eroding real household incomes. In view of consistently disastrous fiscal and monetary policy regimes, it is no surprise that per capita income in US$ terms has largely stagnated over the last five years, while it continues to grow for the region, and economies at similar stages of development.

The inability to rein in the fiscal deficit through privatization, or reformation of state-owned enterprises (SOEs), or through reduction in expenditure will eventually lead to a scenario where the government will continue to rely even more on debt to fund its deficits. The country has reached a position where mark-up expenses on debt make up more than 70 percent of tax revenue that is generated by the government. If things are not sorted, then this may continue to increase further, such that mark-up expenses take up a greater proportion of tax revenue, leaving little for development or social expenditure without relying on more debt.

It is imperative to note here that, as the government continues to crowd out private-sector borrowing, by increasingly taking on more debt, any growth through investment in the economy will be difficult to achieve as the private sector may not be able to get access to credit given the overbearing reliance of the government on debt. The crowding out of the private sector eventually means lower economic growth through investment and lower creation of jobs. Moreover, the inflation that is generated as a consequence of fiscal deficits will continue to erode household incomes, and savings in real terms.

Government budgetary support relative to broad money being at its highest-ever level is a serious cause of concern, and if it is not controlled over the next few quarters, inflation will continue to increase, and erode the real disposable income of the people of this country. We can either improve our policies and ensure that there is sustainable growth, which increases household incomes, or we can continue to run perpetual deficits and erode the prosperity of millions of households across the country through inflation. More money eventually leads to more problems in this case.


The writer is an independent macroeconomist.