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Issues in the management of Pakistan Debt

(By Hafiz Pasha)

Pakistan’s debt stands at Rs 18,241 billion as of end- June 2014. This includes Rs 16,321 billion of government (public) debt, equivalent to 89% of total debt. The rest, Rs 1,920 billion, is owed by public sector enterprises, banks and companies, mostly with external creditors. Public debt has mushroomed rapidly since 2006-07. It was Rs 4,896 billion in June 2006-07, and has risen annually by 19%. At this rate, it is effectively doubling every four years. Today, each citizen of Pakistan has the burden of debt of Rs 87,200 on his/her head.
External debt, both public and private, has also accumulated rapidly. It was $40.5 billion seven years ago and now stands at $65.5 billion. However, the share of the public component of external debt has fallen during this period from 94% to 84%. A number of questions arise, given the large size of debt. Is the country already in a ‘debt trap’? Will we be able to meet the future debt servicing obligations, especially with regard to external debt? What should be the future debt management policy?

When is an entity in a ‘debt trap’? This is a situation in which there is no money to service past debt and there is need to take loans to meet the outstanding debt obligations. This leads eventually to a crippling cycle and rapid accumulation of debt. In the context of a government, this means that it should have enough revenues to cover all non-interest related expenditure. That is, there should be a ‘primary surplus’. This surplus can then be used for making interest payments. If this is the case, then it can be said that the country is not in a ‘debt trap’.

The federal and provincial governments of Pakistan did generate a ‘primary surplus,’ for most of the years up to 2013-14. Since then there has been a primary deficit, implying that we have entered the ‘debt trap’. This deficit peaked at almost 4% of the GDP in 2012-13. Credit is due to the government of PML (N) which has brought it down to less than 1% of the GDP in its first year. But more needs to be done to break out of the ‘debt trap’. Regarding the issue of external debt sustainability a number of indicators have been used. A popular measure is the ratio of external debt and liabilities to total exports. In 2006-07 it was 237% which rose to 244% by 2012-13. The ratio has risen sharply to 261% in 2013-14, because of a peak in net external borrowing during the year of $5.6 billion. Other indicators also generally point to growing problems of servicing external debt.

The National Assembly had passed the Fiscal Responsibility and Debt Limitation (FRDL) Act in 2005, in order to place a ceiling on the level of deficits and borrowing. According to the Act, total public debt should not exceed 60% of the GDP. At the end of 2013-14, it stands at 64.3% of the GDP, according to the SBP. Also, a revenue surplus must be generated. Instead, despite some improvement, there was a revenue deficit of 1.4% of the GDP in 2013-14.
Therefore, the message is clear. The burden of debt is too large and the fiscal deficit has to be brought down. If, in fact, the deficit is restricted to below 5% of the GDP in 2014-15 then we will come close to meeting the requirements of the FRDL. However, the first quarter has not been promising. FBR has shown a growth rate of only 13% in revenues as compared to the target of 24%. This threatens to increase the size significantly of the fiscal deficit in 2014-15.

Turning to the strategy for public debt management in coming years, the Ministry of Finance has formulated a Medium Term Debt Strategy (MTDS) in April 2014. The salient features of the strategy are raising the maturity profile of domestic debt; widening the investor base of T-bills, PIBs and Ijara Sukuk bonds; focusing on concessionary borrowing from multilateral/bilateral donors; annually floating Eurobonds up to 2017-18 and achieving centralisation and transparency in debt management operations. Successful execution of the MTDS will require generation of primary surpluses of at least one to two percent of the GDP. This implies a vigorous mobilisation effort and strict economy in expenditure. Raising the maturity profile reduces the risk of rollover of short term debt but it adds to the cost of debt servicing. The composition of domestic borrowing should reflect expectations about future interest rates. If these are expected to fall, then more short-term debt may be a preferred option.

The fundamental issue is one of external debt sustainability. The MTDS recommends the floatation of relatively high cost Eurobonds annually. However, the policy should be to only borrow externally up to the level which ensures that reserves do not fall. Therefore, Eurobonds should not be seen as a regular source of borrowing, but only as a last option.

The ongoing hiatus of the IMF programme means that unless it becomes operative once again there could be serious problems in repayment of external debt this year. Accessing the international capital market and receiving programme assistance could also become more problematic. The question is how will the external financing needs of over $10 billion in 2014-15 be met if the Fund’s programme of Pakistan flounders?

The government has pinned its hopes on receiving large external financing of $34 billion from China for energy and other infrastructure projects. While this will add substantially to power generation capacity, it will lead to a big increase in the external debt and also have implications on the balance of payments due to amortisation payments, repatriation of profits and cost of coal imports. For external debt sustainability, exports will have to show a corresponding increase from the additional supply of power. Otherwise, external debt sustainability will become a very serious issue.
Overall, the MTDS of the government has to be changed to have a more long-term focus, with emphasis on projecting external debt obligations and their servicing.

(The writer is MD of Institute for Policy Reforms (IPR) and former Federal Minister)