Why is it so hard to finance budget deficits? Problems of a developing country

Abstract

This paper examines possible ways for a developing country to finance budget deficits by drawing on domestic resources. We do so by analyzing Pakistan’s National Savings Scheme (NSS). The NSS has a number of unusual attributes, and its impact upon the economy of Pakistan is not clear. Given Pakistan’s chronic difficulties with the public sector deficit, the NSS, which is a key instrument in financing that deficit, is of great importance. We use an econometric model to analyze the relationship between the demands for NSS deposits and various other financial instruments in Pakistan. In particular, we look at the relationship between deposits in the NSS, bank deposits, and foreign currency deposits. We conclude that bank deposits and NSS deposits appear to be net substitutes, as do NSS and foreign currency deposits. Bank deposits and foreign currency deposits, however, seem to be neither substitutes nor complements. Also, the estimated income derivative of the demand for bank deposits is negative, while that of foreign currency deposits is positive. For the NSS, it is not significantly different from zero. Finally, is evidence that foreign currency deposits are a net substitute for NSS deposits. Thus, there is some empirical support for the belief that foreign currency deposits have absorbed a part of the demand for NSS deposits. Accordingly, the availability of these foreign currency deposits may have reduced the ability of the government to finance itself.