Treasury bills: a double-edged sword

The surge in public borrowing from banks has significantly elevated the risk of further reducing the availability of credit to the private sector through two channels.

One channel is through reducing the availability of liquidity for lending to the private sector.

Bank liquidity was already constrained by weak deposit growth and their inability to recirculate money through recovery from legacy loans.

Large scale borrowing by government through default risk free instruments is increasingly eating up large chunk of whatever liquidity was left.

Add to this the mandatory transfer of so-called surplus funds of the 60-plus public institutions to the central government exchequer, which will further strain bank liquidity until they are spent by the government.

The other channel is interest rates. Yields on Treasury bills and bonds have increased by 3 to 5 percentage points in the last year and a half. They now range between 7 to 9 per cent depending on the tenor of the instrument.

At a time when the government is imposing a 9 per cent ceiling on bank lending rates to the private sector except for credit cards, and when no effective measure is being taken to reduce the default risk of private lending, banks will naturally be much more inclined to lend to the government where they can get close to 9 per cent with zero default risk.

The increase in interest rates on public bank borrowing has also negated the potential fiscal benefits from the tightening of sales of the National Saving Certificates.

The parts of the private sector most vulnerable to crowding out are the high risk segments such as cottage, micro and small enterprises.

Given the 9 per cent ceiling and plenty of volume in the alternative risk-free lending to the government and relatively low-risk lending to large corporate borrowers with a good repayment record, banks will have to be extraordinarily unwise or philanthropic to be forthcoming in lending to these sectors.

The government needs to consider relaxation of lending rate ceiling for these credit-deprived sector to ensure that progress on the financial inclusion agenda is not set back.

Moving forward, the government will have to find ways to contain public borrowing or even repay the amount already borrowed.

This will require stronger revenue mobilisation, better utilisation of the foreign aid pipeline and expenditure rationalisation.

We have seen a tendency to add to subsidies one after another without any serious thought on their economic justification.

We also hear about wasteful expenditure by public officials on travel, vehicle purchase, and many other amenities.

Individually they appear small, but collectively they add pressure on the budget. There are many domestically funded projects in the annual development programme that can be put on hold without hurting the economy.

Prioritising expenditures must be the first priority in the efforts to contain public borrowing.

Revenue mobilisation can be strengthened first by not adding to tax expenditures through extension of new tax waivers and rebates and second through improving governance in tax administration by expanding in particular the use of automation processes.

Greater focus on accelerating the implementation of foreign-aided projects will help increase aid disbursements.

Particular attention is needed on addressing bottlenecks in public procurement and fund release processes.

The author is an economist