The debt debate

While debt is an essential component of the modern economic system, providing impetus for public expansion and crucial private sector investment, it is its mismanagement that points at unhealthy fiscal deficits and eventually compromises national income and employment. Erection and management of effective debt markets is, therefore, of prime importance for smooth functioning of any economy, especially among emerging markets. And while we see compound negative aftermath of mismanaged debt and deficits in the advanced world, our own unabated borrowing is a lethal time bomb in the making, and if not handled properly, threatens to eat up what little development budget we have left.
The common Pakistani perception of the debt-to-GDP figure concentrates predominantly on public debt, ignoring the mountain of private sector debt that complements state borrowing. Those who have not forgotten the austerity of the late ‘90s will remember the acute debt situation when it stood in excess of 100 per cent of GDP, and we were caught in the infamous vicious cycle of borrowing just to meet debt payments. And while timely participation in the west’s so-called fight against terrorism brought a quantum of circumstantial relief – debt-to-GDP dropped under 50 per cent – relevant authorities still remained shy of addressing the core issue of a runaway fiscal deficit, which creates the need for debt in the first place.
Decision makers now face the demanding task of fashioning policy in a manner that mandates balancing books and contracting the out-of-control deficit. So long as fiscal balance is not in sight, and the government sticks to borrowing to meet short term needs, the debt burden will grow geometrically. Also, with foreign exchange inflows limited, the bigger portion of the debt being in local currency makes it more expensive because of high interest and inflation rates. At the same time, short debt maturity profiles negatively affect repayment capacity and ultimately the same situation of ballooning debt is reached.
Until a few years ago, the foreign-local currency denomination of the debt was 60-40 respectively, which has reversed now. Traditionally the foreign component used to comprise long term cheap loans from multi and bilateral donors while the local component was just the opposite. Now, the situation has changed dramatically, and we are on the threshold of the same situation where we will need to increase borrowing just to meet payment deadlines on the old, inflated debt.
Therefore, there is an immediate need to incorporate fiscal prudence and balance local and foreign currency debt. Also, it is the government’s responsibility to develop and maintain the benchmark yield curve. Unfortunately, when interest rates soared, the government abandoned issuing long term investment bonds and compromised the yield curve. It must now give it serious attention, albeit at a higher price. Yet the importance and need of the exercise dictates that increasing costs be borne by the government. Once developed, market participants can step in and issue investment instruments against the yield curve.
Importantly, investment banks must also put their houses in order. Their core purpose was to exploit long term money generation options to ultimately direct funds towards investment opportunities and social overhead capital that form the backbone of progressive projects. But over time they have abandoned that role for more orthodox commercial and merchant banking. Since their position allows them to extract credit enhancement from credible agencies like ADB, the time has come for the government to force these investment banks into once again becoming market movers.
In short, the government must now take the bull by the horns. It has a number of policy options available, as outlined above, and must bring them together. It must also make the debt management unit of the ministry of finance more effective, something I took up very forcefully in my time. Only the government has the clout to take numerous steps that are needed. If the political will is still lacking, our debt problems are serious enough to erode what little growth we are registering and unemployment, already unbearably high, will worsen.

The writer is a former finance minister