Thursday, August 27, 2009

Rising Debt

Debt is the outcome of fiscal and current-account deficits. The larger the twin deficits the more the government borrows and the more rapidly it accumulates debt. Exchange rate depreciation would cause public debt to grow even faster. Thus, low fiscal and current account deficits, along with stability in the exchange rate, are critical in keeping public and external debt at a sustainable level.

Why should we worry about rising debt burden? This is because it constitutes a serious threat to development; a major source of macroeconomic instability which, in turn, is inimical to growth, job creation and poverty alleviation. A rising debt burden raises the risk of a fiscal crisis. It keeps borrowing costs high and discourages private investment. It also discourages foreign investment as it creates a high-risk environment and exchange rate depreciation. And, most importantly, it constrains the government to undertake a countercyclical fiscal policy to revive economic growth. Fiscal discipline is therefore vital for preventing a debt crisis and maintaining macroeconomic stability – a critical element for promotion of growth, job creation and poverty reduction.

Pakistan pursued a sound fiscal policy and maintained financial discipline from 2000 to 2007). Fiscal deficit averaged 3.8 percent of the GDP, which helped in keeping the current-account deficit low (0.7 percent of the GDP on average). Large foreign capital inflows led to the building of foreign exchange reserves, which rose to as high as $16.4 billion by October 2007. The rise in foreign exchange reserves provided stability to the exchange rate. As a result of these developments, Pakistan's public debt as GDP percentage (a critical indicator of the debt burden) declined from 85 percent in June 2000 to 55.5 percent by June 2007 – a reduction of 30 percentage points of the GDP in just seven years.

Similarly, public debt as percentage of total revenue (another indicator of the debt burden) declined from 589 percent to 371 percent during the same period.

External debt and liabilities (EDL) on the other hand declined from 51.7 percent to 28.1 percent of the GDP--a reduction of 23.6 percentage points of the GDP in just seven years. EDL, as a percentage of foreign exchange earnings, declined from 297 percent to 124 percent--a decline of 173 percentage points. In absolute terms, the EDL was $35.5 billion in June 2000 and rose to $40.5 billion by 2007--an increase of $5 billion in seven years.

The sharp reduction in the country's debt burden was considered "Pakistan's most remarkable macroeconomic achievements of recent years" by the IMF (according to its document on Pakistan, dated Nov 20, 2008). Consequently, it reduced interest payments from 51.2 percent of total revenue in 1999-2000 to 29.8 percent in 2006-07. The decline in interest payment provided much-needed fiscal space to raise development spending. The reduction in the country's debt burden helped investment to rise from 17.2 percent of GDP to 22.5 percent, caused growth to accelerate at an average rate of 5.6 percent per annum and 7.0 percent during 2002-07, unemployment to decline from 8.3 percent to 5.3 percent and poverty to decline from 34.5 percent to 17.2 percent.

The hard-earned macroeconomic stability underpinned by fiscal discipline was lost in 2007-08 owing to the sharp increase in international food and fuel prices, deterioration in the security environment and, most importantly, policy inaction on account of political expediency (particularly, higher energy prices not being passed on to domestic consumers). In 2007-08 budget and current account deficits surged to 7.6 percent and 8.3 percent of the GDP, respectively. As a result, the declining trend in the country's public- and external-debt burden has been reversed and these increased to 57.8 percent and 28 percent, respectively.

The reversal in debt indicators continued in 2008-09. Although the government pursued the right fiscal and monetary policies and succeeded to reduce macroeconomic imbalances to a considerable extent but massive borrowing from external sources coupled with sharp depreciation in the exchange rate worsened the public and external debt situation. In 2008-09 public and external debt further increased to 58.3 percent and 30.4 percent of the GDP, respectively. Pakistan has paid a heavy price for financial indiscipline in the past, is still paying it and will continue to pay it in the coming years unless sharp readjustment is quickly made on the fiscal side to regain macroeconomic stability.

Public debt increased by Rs2,827 billion in just two years (2007-09) as against Rs1,796 billion in the previous seven years (2000-07). The rise in domestic debt contributed to 45.4 quickly (Rs1,284 billion) and foreign currency debt contributed to more than 56 percent (Rs1,543 billion) to the total increase in public debt in two years. The exchange rate depreciation alone contributed Rs944 billion, or 33.4 quickly, to the increase in public debt. In the presence of the high proportion of foreign currency debt in total public debt, depreciation of the exchange rate is not a good policy. Rather than boost exports, it will create more macroeconomic problems.

External debt rose by $11.7 billion in just two years (2007-09), as against $5 billion in seven years (2000-07). External debt is projected to rise to $74 billion by 2015-16–$24 billion more in the next seven years, according to the latest IMF estimate. The IMF debt alone is projected to rise from $1.337 billion in 2007-08 to $11.359 billion in 2010-11–$10 billion more in just three years. What is more painful to note is that Pakistan will have to pay back $8.321 billion to the IMF in the next three years (2011-12 to 2013-14). How Pakistan will manage to retire $8.3 billion to the IMF alone is a serious question.

Unless Pakistan makes strong fiscal adjustments now and in the next fiscal year it would continue to face serious debt problems with all its macroeconomic consequences (low economic growth, rising unemployment and poverty, deterioration of physical and human infrastructure, pressures on exchange rate, discouragement of both domestic and foreign private investment) in coming years. It is in this perspective that I have been advocating tight fiscal and monetary policies.

THE Loadshedding

THE load shedding-driven sleepless nights and disrupted daily routines of last summer are still haunting the people as the weather turns hot. The situation has not improved since last year; indeed all the signs are that it is getting worse. Credit goes to brave Pakistanis for surviving through the winter despite 10-hour power and gas load shedding. But in the upcoming summer when the mercury is going to consistently hover round 40°C, occasionally rising to 50°C in some places, a power crisis of a similar order is going to prove unbearable. Last summer the national media reported tragic deaths due to heatstroke and dehydration. The energy crisis in winter forced thousands of industries to shut down operations, affecting industrial production and the livelihoods of thousands of families.
Considering the indispensability of energy — since 1947, per capita electricity dependence in Pakistan has grown 82-fold — the current state of affairs can be regarded as a ‘national crisis’. The quickest and pragmatic solution — multi-gigawatt capacity addition based on local coal and hydropower — will require at least 2-3 years (5-7 years for hydropower) provided that bold and concerted steps are taken on a war footing.
Assuming optimistically that this will happen, we still have to devise ways in the interim to meet the electricity deficit in the country which has soared to over 40 per cent. The challenge now is how to survive this summer and how to stop the crisis from getting worse. The solution lies in a collective national effort.
Two key elements of a possible solution are: categorical change in the pattern of energy consumption and change in lifestyles.
The current energy consumption trends in Pakistan are extremely inefficient, whether it be in the domestic, industrial, trade or commercial sectors. With minimal effort, well over ten per cent of national electricity can be saved by applying only the first level of energy conservation that is a change in attitude. It is simple, instant and effective and all it requires is a stop to using energy unnecessarily.
Leaving lights and home appliances on even when they are not being used is a common practice in our society. Similarly, many businesses such as shops dealing in cloth and garments, jewellery, cosmetics, home appliances and electronics are usually extravagantly lit. It is commonly observed that shops that could do with two or three 40-watt tube lights to meet the desired level of luminance use as many as 15 to 20 tubes. Not only does this increase power consumption, it also generates heat and makes the environment uncomfortable.
A further economy of 10-15 per cent can be achieved by introducing the second level of energy-conservation practices, especially in industry. Collectively, just through conservation, more than half of the electricity deficit can be met. However to do that, public education is essential. With the help of effective electronic and print media campaigns the government can quickly educate the masses.
The second part of the solution is a change in lifestyles. It would begin with the acknowledgement that the country is facing a national disaster and every citizen has to pitch in to overcome it. The nation has to draw a clear line between necessities (lighting, fans, TVs, computers, etc) and luxuries (air conditioners, microwaves, etc). There is not enough electricity to meet both requirements.
We will have to compromise on luxurious lifestyles in order to meet the necessities. Markets and commercial places can substantially reduce their power consumption by changing their working hours. An early start and early end to capitalize on daylight as much as possible should be recommended rather than having opening hours from afternoon until late at night. Air-conditioning, usually a sign of a luxurious lifestyle, needs to be dropped. Bearing in mind that a typical domestic AC consumes far more electricity in one hour than a fan does over 24 hours, air conditioning should not be allowed except for sensitive applications such as hospitals and research centers. The choice is between using ACs for a few hours and then doing without electricity in peak summer months or avoiding ACs and other luxury gadgets but having round-the-clock electricity available to meet fundamental needs.
Any such policy should be made at the highest level and its implementation should also begin there because charity starts at home. The common man would only be convinced of the looming crisis when he sees the ruling elite practice what it preaches.
The ruling class should lead by example in matters of power conservation. If it does so the common man will follow suit. It is time for the elite to take energy-saving initiatives like abandoning the use of central air conditioning, traveling by special flights and irrelevant use of official transport.
These recommendations are neither impractical nor a step backward, as some sections may perceive them to be. If implemented they can not only avoid the collapse of a bankrupt energy infrastructure but also ensure progress. Even those who have access to easy money and can afford different gadgets such as generators to offset reduced power supply will still feel the heat one way or the other. The bottom line is, in order to safely get through the current energy crisis the nation has to differentiate between its necessities and its luxuries.
If load shedding is still unavoidable despite all these measures, Wapda/KESC should organize the cuts in a sensible way to cause minimum discomfort. Load shedding schedules should be properly planned and announced.