Eurobonds – Magic wand or just another loose thread?

A loan, at the end of the day, is a loan, and will have to be repaid

The official IMF economic report for 2014 arranges two different paragraphs side by side on the general economic health of global economies where each paragraph contradicts the other in a subtle and careful way. Interestingly the report claims that the US economy is not only stable but recovering, however in the next paragraphs depicts another picture

 “These transitions are far from complete, and stability conditions are far from normal. Since October, bouts of financial turbulence have highlighted the substantial adjustment that lies ahead”.

These words are not uncommon even amongst senior global economists, heads of central banks who discretely discredit similar recovery reports and discount numbers coming out of economic indicators. In short, many economists and economic advisors are still not convinced things are stable as yet. Even the most optimistic reports talk about challenges and conditions which if remain unfulfilled would mean that the world global giants will fall back in the red zone and face uncertain economic times ahead. If nothing else, gigantic debts and apathy towards reducing the US debt is cited as the main concern for any recovery.

Where does Pakistan stand when it comes to the global recovery? Interestingly economic managers are boasting recently crossed $10 billion reserve mark, gains of Pak rupee against dollar, preferential treatment of EU commission regarding exports and finally the case of eurobonds. The argument goes deeper and the claims are getting taller by the day.

Governments borrow to finance fiscal deficits and government expenditure, and short term repayments of debt financing.

Is this the turning point in the history of Pakistan? Will we now become part of the “Asian tigers” or close enough creatures which will dominate the economic battlefield, become as potent as economies like Taiwan, Korea, Japan, Malaysia, and Singapore; not to miss the trophy, finally beat India in the fields of commerce and trade? Will the economic downturn for the common Pakistani end, and a new era of economic prosperity began? Or are we beating the trumpet too loud and without any course?

Common claims — US debt crisis and Pakistani economic miracle

Interestingly, both global (US, Japan, and EU) and Pakistani recovery drives have had three things in common. One, both have contradictory claims if not tall ones, regarding economic recovery and yet they do not discredit inherent weaknesses and uncertainties within their systems. The IMF report is a prime example. When US and global economies have not risen out of the crisis, Pakistani economy is more vulnerable and fragile.

Two, EU, Japanese and Pakistani economies are marred with gigantic debts and face budgetary and fiscal deficits which, in case of Pakistan, is far more concerning. The resolution of US and global debt may have some hope after all because the entire world depends upon it.

Three, the two economies, Pakistani and US, are trying hard to convince themselves and perhaps respective citizens that the debt crisis will be over and life will be easy. The most irritating fact is that if the US economy cannot remain immune from the debt crisis, Pakistani economy, which is far more fragile, is sitting on a time bomb of debt. According to some, the current political government’s recent drive to raise forex reserves is through raising debt, and the entire recovery drive is in fact another debt expanding exercise which if unchecked will explode and may lead to yet another economic meltdown.

Our internal debt is close to Rs14,000 billion, while our foreign debt is approximately $56 billion, which is growing far more than revenue sources.

Let me explain the last point in simpler terms; if the US economy is flattened because of an unprecedented increase in its debt, and the possibility of debt ceiling faltering can lead to a global crisis, how can a small scale economy like Pakistan reach heights of economic prosperity by increasing its debt? The two situations are not comparable because of many different economic variables, scales and proportion, but the bottom line is that increasing debt is not a solution. If we can understand this simple point, then we can also understand that floating eurobonds in global market is no different than taking debt at commercial rates.

Eurobonds in a nutshell

There are lots of arguments which substantiate claims that Eurobonds are beneficial and comparatively cheaper than other alternatives. It was over subscribed for one, and many other indicators also suggest it was not a bad option in view of the fact that we can move away from the IMF. However, it is a loan at the end of the day. This needs to be paid back and if it was oversubscribed it also means it was overly lucrative for them (the most troubled economy of Greece too bought the bonds).

In order to understand the long term impact of this loan, it is important to first understand why we seek the loan in the first place. Governments borrow to finance fiscal deficits and government expenditure, and short term repayments of debt financing. In short, we are borrowing to run governments, pay salaries, run Raiwand PM houses, repay short term loans, and pay interest payments for the outstanding long term loans. If we ran the government the way Punjab is being run, we may also end up taking loans to build more Metros, exuberant ring roads (that too restricted to the metropolitan capital), spend on laptops, youth festival, world records, or start making cheaper rotis for the masses.

What are numbers suggesting then? Our internal debt is close to Rs14,000 billion, while our foreign debt is approximately $56 billion (based on 2013 data, numbers are rounded off), which is growing far more than revenue sources. Does it ring an alarm bell? It sure will make many economists paint a scary picture when the debt is increasing at an alarming 5-6 per cent annually in real terms while revenue is increasing at less than two per cent. There is a strong possibility that the present government may miss the tax collection target for 2013-14 again, and many blame its weak tax policy. Others also point at unexplained SROs exempting certain politically powerful sectors. When the government was sworn in last year, it raised the sales tax in an effort to increase revenue which, according to some, had burdened the poor while letting the rich go unchecked. So when government needed to plug its expenditure gaps, pay its debt while its revenue was dropping due to its “weak policy”, the government decided to go to commercial sources and borrow globally and Eurobonds were born.