Options for Financing the Budgetary Deficit, Money Supply, and Growth of Banking Sector

Abstract

The fiscal deficit has assumed alarming proportions in Pakistan; it was as large as 8.5 percent of the GDP in 1987-88. Though it has fallen somewhat in recent years, yet it still is around 6.7 percent of GDP. While the fiscal deficit was expected to result in a high rate of inflation and slow growth of output, Pakistan has sustained a high growth rate of output with price stability. This makes Pakistan a fascinating case study.l The impact of the fiscal deficit on monetary expansion, growth of output and price stability in various countries has been extensively analysed. For example, see Cline (1987); Collins and Park (1989), Corbo (1985,1989); Corbo and de Melo (1989); Corbo and Nam (1988); Dornbusch and de Pablo (1989); Easterly (1989); Edwards (1989); Enders and Mattione (1984); Gil Diaz (1988); Haque (1987); Kim and Yun (1988); Kormendi (1983); Modigliani and Sterling (1986); Nash (1988); Ocampo (1987); Reisen and van Trotsenburg (1988); van Wijnbergen (1987) and Yellen (1989). However, very little work is available on Pakistan. The present study is an attempt to fill that important gap. By analysing trends in the budgetary deficit and in the pattern of financing the deficit, the present study explores their implications for the interest rate structure, monetary expansion, and growth of the banking sector in Pakistan. The paper is divided into four sections. Section I traces the trends in the fiscal deficit over time. Patterns of financing the deficit and implications for monetary expansion are analysed in Section II. Section III examines the implications of changes in the rate structure of interest for the growth of money supply and the banking sector. Section IV presents the main conclusions of the study.