Monetization of the Budget Deficit
By Shan Saeed---Economist
Are we heading for that? It seems most likely that Government of Pakistan’s expansionary fiscal policy will lead us where it might create financial indiscipline and put pressure on the economy further. The budget which has been announced on 5th June and deliberated upon by experts on media has got mixed response. VAT has been abolished according to Secretary finance. But more taxes would be levied in new forms. We need to start following the countries having PFE-prudent financial economies including
Let analyze few facts generally acceptable globally by economic experts, guru, decision makers and economic managers.
Fact Number 1: Government spending can’t really increase the aggregate demand for the economy as consumers cut their own expenditure in anticipation of higher tax. In our case it holds true.
Fact number 2. It is believed that fiscal alignment which relies primarily on government spending cuts and the government wage bill cut will have much higher chance of being successful in providing relief for the economy and is expansionary in nature. Thus it brings fall in price levels, decrease interest rates, stabilize exchange mechanism and above all provide sustainable growth in the GDP rate. This is out of question in
However, we are pursuing a strategy that is relying primarily on tax increase, cut in public/social investment and optimistic figures to provide relief to the poor and employment. This strategy is contractionary and not sustainable for the long run. Putting more pressure on the government revenues will increase expenses that might lead to a budget deficit of over 6% of GDP. Higher tax eat into demand and to quote Japan in 1997 where it enhanced it consumption tax rate, jeopardizing the economic growth rate and falling into recession era or lost decade as they call it.
Government has 3 options to finance it Budget Deficit for its economic management
b) Government Bonds Sales
c) Quantitative easing or printing money or accommodative money supply
Higher taxes are not effective. The reason why Pakistani consumer’s sentiments are so low is that it is believed that government will impose higher tax that would be disastrous for the economy. I often disagree with some economic experts that recession is a business cycle. In fact it is not, Recession is a consumer cycle. When consumers don’t buy, businesses don’t invest; the economy shrinks and heads off to recession. Government’s tool to raise revenues through this option will be ineffective. Taxes work in an economy where documentation is covered widely. In
Government can issue bonds to sweep the money from public hoping to meet its deficit. The game is changing now. Sovereign debt is not safe anymore…The problem in PIIGS and other countries to follow will clearly illustrate that all government debt is not risk-free. Investors might have to pay the price for certainty of getting back their funds at the time of maturity in these turbulent eras.
People won’t be eager to invest in government bonds as high level of inflation 18% [by independent economist] turning their savings into negative zone since effective interest rates [Saving rate subtracted from inflation rate --à 11-18= 6%] will be touching the minus sign. Dis-saving is imperative. This option might work taking into account the global volatility / uncertainty in the financial markets, people may invest in these bonds. They say: in tough times, home is the safest place….Chances is 50-50...Lets see what happens…..
This is a new drug in global financial market as it has come into the market with much more renewed force/vigor and acceptable for central bankers internationally. This was called printing money few years back. This is way budget deficit is monetized to fill in the revenue and expenditure gap of the budget. This option has got huge contribution to inflation, hyperinflation and galloping inflation. But some central bankers [
1. Banks are stabilizing to provide relief to the investors and calm the volatile financial markets
2. Asset pricing are rebounding to make an impact on the global economy.
3. Recovery is questionable and fortunately we have eschewed another great depression of 1930’s but passing through recession slowly.
However, investors have a different point of view. They believe that governments which are heavily into debt, fiscal stimulus will become less effective thus eroding the confidence of market players not only in the short run but also in the long run. Euro is a prime example of this case where markets are upset and punishing the currency which lost its value by 19% [1.46 in December to 1.19 now] in a record 6 months time. Let’s face it, whether we like it or not, we are in a war like situation where our economy is facing many challenges and ultimately we have to resort to QE as well thus monetizing our budget deficit. This is indeed the only viable option to pursue, but it will place pressure on the economy in the form of inflation, slower GDP growth rate, higher budget deficit, higher current account deficit, higher imbalance in payment position, lower productivity, and lower purchasing power, depreciating currency and exchange rate and above all little room for financial maneuvering in the depressing economy. Deficit monetization can be seen as sub-set of debt monetization [$56 billion at the moment] in our long standing deficit economy.Our debt will touch a dangerous level of $75 billion in 4 years time. Debt monetization has two legitimate categories of components viz developmental expenditures that create equity value and can be treated as asset in their own right [constructive assets].
’s deficit perhaps does not fall here, moreover, if we subtract grant, coalition support fund or foreign aid. Pakistan
The question is how can we avoid this monetization of deficit which will put the economy in jeopardy? Do we have a role model to turnaround the economy? What should be the strategic intent of the government taking into account the volatility of the global financial markets that I foresee in the next 2 years? I think we have to focus our efforts of bringing macro-economic stability of the economy, reducing budget deficit and healthy GDP growth rate that would provide lot of room for financial and economic to strategize for the long run.
The strategic game plan in the global financial economy is all about fiscal policy and monetary policy. How do we use it effectively to get the economy out of the debt trap and stand on our own feet?
1. We have to rely heavily in making effective use of monetary policy. Fiscal policy makes small impact while the economy is in slower mode. It is the monetary policy that brings about change and get the economies moving in the growth mode. Empirically it has proved time and again that monetary policy is more effective than fiscal policy. Effective use of both can be helpful for our economy
2. Central bank and finance ministries need to coordinate in implementing policies that are aligned with our interest and taking globally economy into account.
3. We need to follow Prudent Financial Economies to run on a similar growth path that would help our economy to grow rapidly in the foreseeable future.
4. Finally, we need to defined the exit strategy for every policies that we are going to implement in order to provide a time frame and message to market forces and players
In the nutshell, countries have to align their strategic interest and policies with the geo-political, geo economic and geo-strategic location of the region where they are located. If countries don’t follow these prudent and financially savvy economic policies, they are heading for sovereign default. Countries will be questioned for their monetary manipulations that would give rise to global imbalances.
Writer is MBA from Uni. Of