Financing of 2011 Budget goes haywire

• Reliance on bank financing shoots up to Rs. 191.8 b or 357% over approved estimate of Rs. 42 b
• Rs. 136 billion bank credit to Govt. so far this year way above Rs. 64 b approved in 2012 Budget

Whilst the Government could be commended for almost sticking to its targeted deficit in the Budget, its financing has gone haywire, as per the Central Bank 2011 Annual Report raising fresh concerns.

When Finance Minister President Mahinda Rajapaksa presented the 2011 Budget, he assured the Parliament that bank financing of the targeted 6.8% deficit would be Rs.42 billion. However the 2011 Central Bank Annual Report released on Monday reveals the actual picture, with the eventual figure being a staggering Rs.191.8 billion or an increase of 357%.

The 2011 Budget deficit was marginally off the mark at 6.9% or Rs.450.1 billion as per provisional data, up from Rs.433.7 billion as per the approved estimate.

Following the April monetary policy review, the Central Bank in its statement last week stated that credit to the Government in the first two months of this year had swelled to Rs.136 billion.

Whilst this is over 70% of 2011’s full year amount, what is of greater concern is that the year to date amount in 2012 has overshot itself from the 2012 Budget’s approved estimate of Rs.64 billion. As opposed to zero provisioning in the 2011 Budget, the Government had borrowed Rs.185 billion from the Central Bank to finance the deficit whilst the balance of Rs. 6 billion had come from commercial banks. The reliance on bank borrowing for the budget deficit in 2011 comes after the net repayment of Rs.1.9 billion overall in the previous year and Rs.32 billion to the Central Bank.

Crowding out of the private sector via heavy Government bank borrowing is regarded as a negative development by economists and the Treasury’s greater reliance also comes at a time when interest rates on the rise.  On the other hand, if not for the Treasury, questions have been raised whether there would be a functioning primary debt market in the country.

The Central Bank in its 2011 report reasoned the shift from non-bank to bank sources in financing the budget deficit in 2011 to relatively lower interest rates prevailing in the government securities market up to the third quarter of the year, which motivated the non-bank sector to seek alternative sources of investments giving a higher return.



“However, from the beginning of the fourth quarter of 2011, primary market yield rates started to move up mainly due to the tight rupee liquidity conditions

in the domestic money market. These market developments led to an increase in purchases of government securities by the Central Bank from the primary market. This together with the open market operations carried out by the Central Bank, ownership of government securities by the Central Bank increased to Rs.169.8 billion at end 2011 from Rs.2.1 billion at end 2010,” the report added.

During an interaction with the media after the launch of the 2011 Annual Report, Central Bank Governor Ajith Nivard Cabraal expressed hope that though there had been Rs.136 billion in bank credit to the Government, it is unlikely to be the trend for rest of the year. He suggested that the Treasury will rely more on non-bank sources to bridge the deficit.

As per the 2012 Budget approved in November last year, the targeted 6.2 per cent budget deficit will be financed to the tune of Rs.207.6 billion via non-bank sources, up from Rs.44 billion in 2011. There was a reversal in 2011 since the approved estimates of 2011 indicated non-bank borrowings of Rs.248 billion.

The Central Bank 2011 Annual Report said that the fiscal deficit in 2011 was mainly financed through domestic sources. Accordingly, domestic financing accounted for 51.4 per cent of total financing, while foreign sources contributed the balance 48.6 per cent.

However, the contribution from foreign sources to finance the deficit was higher than the original estimate, while domestic financing was less than what was envisaged in the budget for 2011. Consequently, net foreign financing (NFF) amounted to Rs.219 billion compared to the original estimate of Rs.143.8 billion, while net domestic financing (NDF) amounted to Rs.231.2 billion compared to the original estimate of Rs.290 billion.

The Government also relied more on marketable debt instruments to finance the budget deficit in 2011.