Economics of loans

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    There’s only one way out

     

     

    He was of the opinion that the government should encourage local investors in the market to increase investment, which in turn would attract FDI

     

    For a poor country like Pakistan, foreign loans are a lifeline it can’t afford to lose. Pakistan averted a Balance of Payment (BoP) crisis in 2013 by submitting to a $$6.6 billion loan from the International Monetary Fund (IMF), which ended last month.

    Coinciding with the culmination of the IMF loan is the government’s decision to issue $1 billion five-year Sukuk bonds at a rate of 5.5pc in order to pay back maturing loans.

    The usual course of action for allocating loans is that they are either invested in development projects, which can generate returns in the future to pay back, or the money is allocated to avert financial crises.

    What begs attention is the vicious cycle Pakistan’s government has got itself into – borrowing more for paying off previous loans.

    External loans borrowed by the incumbent government over the last three years amount to $24.93b, taking the total external debt to $58b. Officials from the debt office at the ministry of finance downplay the increase by saying that the government spent $11.95b in repayment of previous loans, and hence the net addition is only $13b.

    Add an internal debt of $15b used for bridging the budget deficit and aid in day-to-day functioning, the situation looks very grim.

    “Both internal and external debt are a threat to the country’s economy, with the latter posing a greater threat due to being in a foreign currency,” said Salahuddin Ayyubi, assistant professor of economics at FC College, Lahore.

    The debt to GDP ratio has exceeded the 60pc limit imposed by the Fiscal Responsibility and Debt Limitation Act 2005, and is currently 66.5pc of GDP.

    “The government has been violating this Act for the last three years,” said Ayyubi.

    He said loans from the IMF often carry strict conditions that can bring down the entire economy. Such conditions are usually in the form of increase in electricity tariffs or indirect taxes on commodities such as petrol, to be borne by the common man.

    Coinciding with the culmination of the IMF loan is the government’s decision to issue $1 billion five-year Sukuk bonds at a rate of 5.5pc in order to pay back maturing loans

    These measures are taken to ensure that the government pays back the loan. A Letter of Intent is sent to the IMF by the government stating the different steps it would take to pay back the loan.

    In addition to payments of interest and principal amount, IMF also seeks political favours from the government, Ayyubi added.

    Loans from the World Bank, on the other hand, are linked to specific projects and can therefore be linked with project returns in order to pay back the amount.

    “The problem is that money raised from taxes and increase in tariffs is in local currency. Foreign loans are usually paid back in the same currency they were borrowed in,” said Ayyubi.

    Also, some projects have the ability to generate returns which can pay back the loan in a shorter span of time, such as upgrading machinery of state owned enterprises.

    However, projects in the education sector and the like typically incorporate larger time lags before generating economic returns, thereby mismatching the payment schedule of the loan.

    “The government should devise a balanced portfolio of projects wherein some projects reap returns early and some in the long term,” the assistant professor added. This would help schedule the payments accordingly.

    The core problem that the country faces is of having low exports and low Foreign Direct Investment (FDI); if improved, it would reduce the dependence on foreign loans.

    The government needs to diversify its exports in terms of the variety of items and the destination of export by adding more partners. Exporters should be given incentives to increase trade.

    “Value-added goods rather than basic goods should be the focus of exporters in order to remain competitive in the international market.”

    He was of the opinion that the government should encourage local investors in the market to increase investment, which in turn would attract FDI.

    The only way to wriggle out of this vicious circle of borrowing is to increase exports and improve the business climate in the country so that the dependence on loans can be reduced.

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