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Government borrowing: Keeping a close watch on inflation

Asjadul Kibria | Published: January 07, 2020 20:13:57 | Updated: January 14, 2020 20:56:05


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Slower growth of private credit has sparked a debate in the country. Some argue that it reflects lower demand of capital for private investment which may ultimately affect the overall economic growth. Again, some others argue that excessive borrowing by the government is the main reason for slowdown in private credit growth and this will impact negatively on economic growth in the current fiscal year (FY20). The country's Gross Domestic Product (GDP) grew by 8.13 per cent in the last fiscal year (FY19). In the current fiscal year, the government is expecting 8.20 per cent GDP growth.

During the first four months (July-October) of the current fiscal year (FY20), private credit growth came down to 10.70 per cent which was 15.0 per cent in the same period of FY19, according to the central bank statistics. At the same time, net bank borrowing of the government registered 42.50 per cent growth while it was 2.10 per cent in the same period of FY19.

Central bank statistics also show that government borrowing from Bangladesh Bank jumped by 125 per cent in the first four months of the current fiscal year while borrowing from the commercial banks increased by 29.40 per cent. Theoretically speaking, if government borrows directly from the central bank or by printing money, there is an increase in money supply which may subsequently cause price inflation to rise. The ratio of the government's net borrowing from the central bank in comparison to overall net borrowing from the banking system also increased to 18.60 per cent in the first four months of the current fiscal year which was 11.60 per cent in July-October period of FY19.

All this indicates that government is actually printing money to borrow which is increasing the money supply in the market and pushing inflation.  Monthly inflation rate increased to 6.05 per cent in November from 5.62 per cent in July in 2019, according to Bangladesh Bureau of Statistics (BBS).  

Thus, the current trend of government borrowing is inflationary in nature. It appears that taking advantage of moderate rate of inflation, the government is borrowing heavily from the central bank directly. By doing so, it is possibly trying to avoid excessive borrowing from commercial banks.

Nevertheless, around 30 per cent jump in the government borrowing from commercial banks during the period under review is not a normal phenomenon. In the same period of last fiscal year, there was around 3.80 per cent decline in government borrowing from commercial banks.

Will high rate of government borrowing from commercial banks create a crowing-out effect on private investment? Policy makers need to ponder the issue seriously.

WHAT THEORY SAYS: Crowding-out effect of public borrowing is a situation when government's high borrowing from banking system leaves inadequate amount of credit for the private sector in the system.  The theory is widely used to analysis the impact of government borrowing. Classical school of economics argues that the government's excessive borrowing from any source reduces the financial assets for private sector. Keynesian school argues that due to government's heavy borrowing from the banking system, higher demand for credit pushes interest rate up making borrowing costly for the private sector.

This is, however, not well-established that high or excessive borrowings by the government always crowd-out private credit or private investment. Many economies in the world in different periods of time experienced excessive government borrowing without negatively affecting private credit.

It is to be noted that there are two major components of government borrowing from domestic sources. One is borrowing from the banking system. Another is borrowing from the non-banking sources by selling savings certificates. To finance budget deficit, the government borrows from commercial banks through treasury bills and bonds and sometimes also from the central bank directly. Moreover, public sector entities other than the government also borrow from the banking system to finance quasi-fiscal deficit.

DATA TALKS: Data on credit of the current and previous fiscal years may be reviewed to see whether any linear trend exists. Lower section of Table-1 presents the credit growth trend during the first four months of previous four fiscal years (FY16-FY19) along with the current year (FY20). It is observed that there is a big fluctuation of growth in the government's net borrowing. At the same time private sector credit growth shows relatively less fluctuation.  The growth rates hovered between 10.90 per cent and 17.80 per cent during the period under review. Thus private credit has some consistent trend. 

Again, in some cases when there was negative growth of the government's borrowing, there was a robust growth in private sector credit. This is, however, not the regular trend. Similarly, excessive rate of government borrowing is not always linked with the modest growth in private credit as seen in July-October period of FY20. A long-term data may be helpful to get a better picture. Upper section of the table also presents data for a 12-year period of FY07 and FY19.

From this trend, it appears that there is also a big fluctuation in government's net credit growth while private credit growth is mostly stable. Private credit growth ranged between 10.80 per cent and 25.80 per cent during the period under review. Negative government borrowing is also not linked with high growth in private credit. In FY10, net government borrowing declined by 6.50 per cent while private credit growth jumped by 24.20 per cent. Again, in FY17 government borrowing registered a negative 14.80 per cent growth when private credit recorded 15.70 per cent growth. In FY18, with negative 2.50 per cent growth in government net borrowing, private sector credit registered 16.90 per cent growth. 

Another issue also needs some close scrutiny. The table presents a comparison in the ratio of government's net borrowing to total domestic credit and the ratio of private credit to domestic credit. It is clear that private credit in terms of domestic credit has increased consistently since FY06, from 74.16 per cent to 88.09 per cent in FY19. As a result, ratio of net as well as total government credit to total domestic credit has declined during the period under review.

The trend thus indicates that growing demand of private credit has largely been accommodated and also reflects the incremental contribution of private sector in the economy.  The ratio of private credit to domestic credit, however, declined to 86.05 per cent in the first four months of the current fiscal year from 88.65 per cent in the same period of FY19. Though the decline may be linked with the excessive borrowing by the government in July-October of FY20, it needs some caution and calls for better monetary management.

 

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