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.