As Pakistan pays IMF the third installment of $ 107.6 million of the Stand-By-Arrangement, the sustainability of its debt raises fresh concerns. The global financial crisis, sovereign debt crisis and balance sheet crisis have ravaged the global economy. Pakistan has also been caught in the meltdown and is facing acute problems of a twin deficit, unsustainable public debt, massive fiscal imbalances, unemployment, erosion of incomes, liquidity crunch, squeezing fiscal space, and drying up investments. Pakistan has to resort to external and internal borrowing to bridge the twin deficits and to fill the financing gap.
Pakistan’s debt-to-GDP ratio is close to 60%. Its debt liabilities crossed Rs. 12 trillion in 2011, resulting in debt servicing (including interest payments) to the tune of 43.7% of the government revenue. Rising debt is a drag on macro-economic stability, growth and development. It is also a major source of fiscal and current account deficits, thus aggravating the fiscal crisis which is reflected in such further complications as pressure on the exchange rate (widespread exchange losses in public debt portfolio) and diminishing private sector investment. Higher indebtedness also translates into low credit rating by credit rating agencies which in turn discourages FDI and foreign portfolio investment. Higher debt-to-GDP ratios suppress output, private consumption and government spending on public goods such that welfare costs increase with every incremental increase in debt.
Pakistan is experiencing a linear increase in debt. With high debts, interest payments also increase, thus increasing both debt servicing and interest payment burden. Hence, higher debt levels make stabilization more costly and induce shirking by governments. Previously, our debt had a higher dollar component while now rupee component has increased rapidly due to internal/ bank borrowing. The ‘local’ component has implications for the budget whereas the ‘foreign’ debt component affects the balance of payments equation, although that part is known to be used for budgetary support as well. Due to increasing debt stock, the medium term outlook for Pakistan is quite bleak. IMF’s country report No. 12/35 of February 2012 reflects stagnation in country’s debt situation, with budget deficit close to 7%. External debt is projected to be at 70.3 billion in 2014-15. Economists argue that debt (both internal and external) has a negative relation with growth. This debt is a result of structural weaknesses within the economy and the external account.
The large accumulation of debt has been due to heavy tilt towards public debt increasing by Rs. 6,924 billion in four years, against only Rs. 1,784 billion in the 7 years period. Our total public debt liability accumulated during 60 years was Rs. 4,802 billion, to which Rs. 6,924 billion were added in only four years, taking the total to Rs. 11,726 billion. External debt and liabilities also increased by app. $20 billion in four years against an increase of only $1.6 billion in the previous seven years. Our domestic debt was only Rs. 2,600 billion in 2007-08, which increased to Rs. 6,864 billion by end 2011. Similarly, the foreign currency denominated debt has increased to Rs. 4,861 billion from Rs. 2,201 billion during the same period, taking the total public debt liability from Rs. 4,802 billion in 2007-08 to Rs. 11,726 billion by end 2011. Exchange rate depreciation has contributed substantially to the spike in debt, as the value of rupee plummeted from Rs. 60.6 per $ to almost Rs. 100 per $ as of now.
Pakistan has been almost continuously under an IMF program for over two decades. The IMF is supposed only to make funding temporarily available for emergency relief and not for economic distress due to un-payable debt. IFIs are pressing for fiscal tightening instead of debt relief. Pakistan needs a viable and successful exit strategy from the debt trap. The strategy has to work on several parameters. The foremost requirement is a focus on macroeconomic stabilization with a close attention to fundamentals, including a resolve to reduce the twin budget and current account deficits through tight fiscal discipline and consolidation. Any further borrowing should be strictly need based with a strict eye on the interest rate, maturity period, amortization payments and currency fluctuations. Exchange rate volatility, uncompetitive devaluations and instability of domestic financial markets together act to discourage the lenders from extending loans in times when weaker economies require greater liquidity through capital injections. The debt management strategic has to be a mix of rescheduling, strict adherence to the Debt Limitation and Fiscal Responsibility Act, fiscal consolidation, and seeking debt at concessional rates as well as a possibility of debt swaps (e.g. debt relief through Paris Club – I, II & III in pursuance of Paris Club Agreement of 2001 when Pakistan’s entire debt was rescheduled on the basis of an extended repayment period). Only such loans should be negotiated which have a lower cost of borrowing, with a room for rescheduling and improving the maturity profile. Our policy makers should seriously pursue the route of debt restructuring, like the Paris Club restructuring. Debt accumulation is basically associated with a lack of regard to the Debt Limitation & Fiscal Responsibility Act. The government should also set for itself debt reduction targets.
The government needs an effective debt management policy whereby debt obligations are assessed on a five to ten year horizon. Short term macroeconomic stabilization tools include the use of monetary policy to control short-term nominal interest rate, fiscal policy to regulate spending decisions on public goods, and decisions related to financing public expenditure either by raising revenue through taxes or incurring debt. Not cutting government spending leads to further increase in debt, high debt servicing and interest payments. Higher debt level necessitates higher taxes. If a fiscal policy curtails expenditure but at the same time does not increase tax collection, the effects of a recessionary shock linger longer than the shock itself because governments are tempted to use inter-temporal margins for further fiscal consolidation. Some governments, while reducing expenditure also reduce income tax collection to decrease the impact of economic shocks on households, which is unsustainable in the long run. This is paradoxical because by not to raising taxes the government keeps the deficit high as before.
More importantly, in the wake of the 18th amendment, the provinces can raise their own debt. This has the downside of public debt accumulation at the sub- national level. It is most likely that the provinces will follow the federal government route of resorting to bank borrowing which has to be discouraged at all costs.
