Living dangerously with debt - Dr Ashfaque H Khan - Tuesday, March 20, 2012

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Pakistan’s debt has grown rapidly in recent years. At the end of June 2007, the outstanding stock of public debt totalled Rs4.8 trillion rising to Rs11.7 trillion by the end of December 2011. In just four and a half years, Pakistan’s public debt has more than doubled. Public debt grew both in absolute term as well as in relation to the GDP. It rose annually by 23 percent during the period and has come to outpace the growth in nominal GDP, thereby increasing the country’s debt burden.

Within public debt, it is domestic debt that has grown at a faster pace (over 25 percent per annum) than external debt. The extraordinary surge in domestic debt is more worrisome because it is relatively more expensive. Interest payment has emerged as the single largest expenditure item in the budget, of which the payment on domestic debt accounts for over 90 percent of the total.

Within domestic debt, the composition has undergone considerable changes in the last four years. Medium-to-long term debt is being converted into short-term debt with serious consequences for government’s debt management strategy. Today, more than one-half of the domestic debt (Rs3.3 trillion) is of short-term maturity, which must be rolled over at least once a year. Besides refinancing over Rs3 trillion of short maturity debt in a given year, the government also needs money to finance its current year revenue-expenditure gap. Debt management has therefore become a nightmare for the policymakers. It has exposed the government to rollover and interest rate risks.

External debt and liabilities also rose sharply over the last four and a half years. The total outstanding stock of external debt stood at $40 billion by end June 2007, but rose sharply to over $61 billion by end December 2011 – an addition of $21 billion during the period. Had it not been for the suspension of the IMF programme, Pakistan would have added another $3 billion in debt.

Many factors have contributed to the recent surge in debt; prominent among these are persistence of large fiscal and current account deficits, sharp depreciation of exchange rate, higher discount rate and, most importantly, the evolution of a cavalier attitude towards debt. Large fiscal and current account deficits necessitated more borrowing, both in rupee and foreign exchange, by the government. The depreciation of exchange rate alone has added Rs1400 billion. The attitude towards debt has been a transformation from a hesitancy to borrow to an intense use of borrowed resources during the period.

High and rising debt constitutes a serious threat to economic prosperity for a number of reasons. It acts as a major impediment to growth, and hence to employment generation and poverty alleviation. It discourages both foreign and domestic investment because it creates uncertainty about the government’s policy and crowds out private investment. It further puts pressure on the exchange rate thereby causing sharp depreciation with an attendant rise in public debt and inflation. It also discourages the government from undertaking structural reforms in the various sectors of the economy.

The unprecedented surge in debt over the last four and a half years has already caused serious damage to the economy. Investment is at a 37 year low, foreign investment has collapsed, economic growth has slowed to an average of less than 3 percent, and unemployment and poverty have risen. The Pakistani rupee has lost over one-third of its value, which has further aggravated the country’s debt situation with inflation persisting at double-digits for 50 months in a row.

What is there in store for Pakistan in the next two years (2012-13 and 2013-14)? Although Pakistan has not yet arrived at the point of almost total collapse as witnessed by Greece, Italy, and other Eurozone countries, but the critical ingredients that brought the them to the brink are very much present today in Pakistan. For example, the culture of patronage, fiscal indiscipline, bleeding PSEs, higher budget deficit, unsustainable debt, bad governance, and persistence of slower economic growth are some of the common elements present in today’s Pakistan. If the status quo is maintained, Pakistan may face a similar situation in the next two years when it will have little resources to meet its external debt obligations.

Heavy debt repayment is expected in the next two years. Pakistan may be able to service its external debt to the extent of over $5.0 billion this year, of which, $1.46 billion is to be paid to the IMF alone. However, it may face serious difficulties in meeting external debt obligations which are expected to be over $9 billion each in the next two years, of which, Pakistan will have to repay about $4.3 billion in 2012-13 and $4.8 billion in 2013-14 to the IMF alone. Such a sharp jump in repayment would put Pakistan’s balance of payments in total disarray.

What should Pakistan be doing to protect itself from the impending debt crisis? Pakistan must take the following steps: i) reduce fiscal deficit to 3.0 percent of the GDP in three years by mobilising additional resources, taking bold decisions regarding the bleeding PSEs, reducing power sector subsidies through improvising efficiencies; ii) accelerate privatisation programmes with enhanced transparency; iii) maintain stability in exchange rate; iv) change attitude towards debt from intense borrowing with pride to borrowing only when necessary; v) revisit the NFC Award; and vi) undertake growth-critical reforms to revive economic growth.

Pakistanis are born free but they are in shackled in debt. Unprecedented surge in debt is the road to ruin and the failure to repay will be a breach of trust with disastrous consequences. No growth and prosperity can be achieved without reducing the country’s debt burden. Can our political leadership rise to the challenge? Can our economic managers tell the truth to the political leadership?

The writer is principal and dean at NUST Business School, Islamabad. Email: ahkhan@

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