DEBT CRISES & INDEPTH DETAIL ANALYSIS RELATED TO PAKISTAN
PRESENTED TO PROF ILYAS FINANCIAL ECONOMICS DEPARTMENT SUPERIOR UNIVERSITY LAHORE
Abstract This paper estimates Pakistan’s external debt by using Debt Sustainability Assessment (DSA) technique. The main findings of the paper are that as a result of small individual shocks to main components of external debt evolution i.e., real GDP growth, non-interest current account balance to GDP ratio and the ratio of net non-debt creating capital inflows to GDP, the country’s external debt to GDP ratio will increase though, but would remain within safe limits. Secondly a significant 30-40 percent depreciation of the exchange rate has the potential to cause the debt to GDP ratio breach the debt threshold level identified for Pakistan. Finally, a large combined shock to real GDP growth, noninterest current account balance to GDP ratio, and the ratio of net non-debt creating capital inflows to GDP together will also result in a need for another debt rescheduling. Keywords: external debt, sustainability, Pakistan Introduction The very basics and fundamentals of any economy are its revenues and expenditures, its foreign investments, gap between expense and revenue either positive or negative. To begin an analysis over almost decade long efforts and labor to rectify erroneous policies and country suffering from debt and investment dilemma and investors shy of coming in Pakistan due to poor economic fundamentals in 1999, I have followed a path to first identify these problems and then to comment on the steps taken by the government, backed up with some solid arguments. Government followed a two pronged strategy fiscal expansionary policy and a monetary policy leading to single figure interest rates. The first step to check gap between income and expense was to lessen the costs of running the government and curb hemorrhaging, CBR reforms and documentation of economy to enhance revenue and capitalize on true potential (Musharraf on PTV program Aiwan-e-Sadr Sey “On Economic Development of Pakistan” told about initial problems faced by us and ways available to expand size of economy). Owing to these reforms Pakistan Federal Board of Revenue has achieved a record target of one trillion rupees which never went above Rs.306bn since 1947, fiscal deficit went down to 4% from 10% in the decade of 1990’s(The News Article “Musharraf recounts economic achievements”). monetary policy that aimed at lowering down the interest rates in order to create more money supply in the economy, thus giving rise to borrowings by the businesses for business activity resulted inhigher rate of employment and lowering down poverty. According to the Economic Survey of Pakistan 2005-06 unemployment went down from 8.5% to 6.5% (Site; CIA World Fact Book - Pakistan) and 5.82mn new jobs were created in this year, 1,14,737 new jobs only in IT sector. Spending on poverty in last five years were Rs.1,332bn, people living below poverty line reduced from 34.46% in 2000-01 to 23.9% (Site; CIA World Fact Book - Pakistan) and International Monetary Fund says to 29% but still it went down. Pakistani economy had seen a long recession after Ayub’s regime till 1999 mainly due to political unrest and lack of political will to do some thing for the country, after 99 again a dictator took a task to infuse a new spirit into the moribund state of our country. Now to continue from the taking off stage – third stage of development which we had already achieved in late 1960’s our planners sought to make a two pronged strategy one were short term goals which were aimed at changing the monetary policy, lowering the
discount rates and communicating moral suasion to the commercial banks to start lending at low interest rates to increase money supply. This lead to mass consumption, people started borrowing at low interest rates and instead of keeping money in banks started investing in businesses; this in turn gave rise to more employment and generally created a win – win situation for all. Ultimately people started investing heavily in KSE 100 index, shares of all public listed companies went up, they started earning more and thus more dividends and profits returns were received by stakeholders. Consumption trends changed and services sector share in the economy ultimately constituted about 3/5 of our economy, agricultural growth could not achieve its projected targets but survived due to colossal growth of 8% in live stock and poultry in 2005, due to high consumption of meet products. All manufacturing concerns instead of purely manufacturing the products started importing and assembling the home appliances, motor bikes and all consumer items, because there was huge demand. External debts started to rise; now they’re at $2627bn. Basic pay scale rose from Rs.1500 to Rs.4600, low interest rates, easy borrowing conditions and high demand and abnormal buying patterns created altogether a consumption oriented economy where everyone was in pure ecstasy. We were successful in reaching the fifth and final stage of a developed country but this stage of massconsumption was not backed up by mass production which is an essential element for sustainable growth and development. So in order to fill this gap and achieve sustainable growth current regime came up with multifaceted strategies in their fiscal policy which is aimed at high budgetary allocations in those sectors of economy that needs financial boost and help from the government. There are two main approaches towards achieving growth in any financial sector one can be purely economic or revenue oriented spending and other is strategic or capital oriented spending. In past, all budgetary allocations were aimed at achieving higher returns and not on infrastructure development projects that was the main reason that our country always lacked basic infrastructural needs and wants. Now if we have identified our selves as a trade corridor for transportation of energy rich Central Asian Countries CARS untapped export market to the countries in north, but we were not well equipped to exploit it, with our current geo-strategic position in the region, for this reason the emphasis of government expenditure has shifted from purely economic to strategic or long term plans. A vision that envisages a long term benefits for the country rather than having short term un sustainable approach, though these long term goals would take time to reveal their benefits. These include Gawadar Deep Sea Port with coastal highway to act as an outlet and trade corridor for energy resources of CARS to China, Daulatabad highway to connect Pakistan to central Asian Republics, expansion of KKH, Dams, Nuclear Power projects, barrages, canals, Thal coal project and tri-partite gas pipeline project (IPI Iran-Pakistan-India pipeline project), roads to link Pakistan – Afghanistan – Turkmenistan and many others. The main focus of Musharraf lead regime is to make best use of our Geo-strategic position by making Pakistan a trade hub (“Consider Pakistan as hub that links the East and Western regions and we need to make use of our geo-strategic position in the region”). To improve its fiscal position, the Government intends to enhance the tax to GDP ratio that has remained stagnant at around 13 percent as a result of a narrow tax base, weak tax administration, a complex tax regime, and widespread culture of tax evasion and corruption. For this, the Government is focusing on improving tax policy and strengthening tax administration.
LITERATURE REVIEW IN DETAIL Pakistan’s external debt burden, measured by external debt and liabilities to GDP ratio, after remaining considerably higher in 1980s and 1990s has recorded significant improvement in the past few years. A large debt re-profiling given by Paris Club creditors in FY02 along with a general economic revival in the country materialized this improvement.1 The impact of these positive developments, however, has been diluted by a significant expansion in country’s current account and fiscal deficits during FY07 and FY08 due to a sharp increase in the aggregate demand.2 To finance rising deficits the absolute level of external debt has recorded a large US$ 9 billion increase for the last two years, again raising concerns about the sustainability of country’s external debt stock in the medium term. The analysis of sustainability of external debt is important given the adverse implications of a debt overhang3 on economic growth. Some of the disastrous consequences of a debt overhang are: limited and costlier availability of foreign financing in future, additional tax burden on economy to pay the debt, and greater uncertainty in the economy. These factors discourage investment and hence squeeze economic growth of the country [Monteil (2003)]. This paper aims to evaluate external debt sustainability of Pakistan by using the standard Debt Sustainability Assessment (DSA) approach developed by IMF and World Bank [IDA and IMF (2004, 2007), IMF (2005) and World Bank (2005)] elaborated thoroughly in Wyplosz (2007). The main findings of this paper are that in response to small one-half standard deviation individual shocks to export growth, real GDP growth and the ratio of net non-debt creating capital flows to GDP, country’s external debt to GDP ratio although increases, but remains within safe limits. A very large depreciation of exchange rate, however, has the potential of causing the debt to GDP ratio to breach the debt threshold level indentified for Pakistan. In addition, a large combined permanent shock of one standard deviation to real GDP growth, export growth and the ratio of non-debt creating capital inflows to GDP can also result in a need of another debt rescheduling for the country in the medium term.
1 During this period country recorded higher GDP, LSM and export growth. In addition higher inflow of remittances and FDI also reduced external financing needs of the country. 2 In addition, the recent external shock coming in the form of higher oil prices and poor harvests domestically further aggravated the economic scenario leading to further worsening of the current account deficit. 3 Debt overhang refers to a situation when the face value of a country’s external debt is higher than the presentvalue of the debt service payments which the government is willing to make for indefinite future.
After the so-called ‘lost decade’ of 1990s, Pakistan’s economy rebounded in 2000s by posting impressive growth rates with relatively stable prices. There are some of the key indicators of Pakistan’s economy that present a reasonably stable macroeconomic environment. The average growth rate of more than 6 percent since 2004 in Pakistan was observed on the back of favorable developments in various sectors. Inflation recorded two fold increases of 9.30 percent in 2005 as compared to the previous year of 2004. This hike in inflation was observed for the first time since 2000, as it remained below 5 percent most of the time (from 2000-2005). During the next two years, however inflation increased, albeit less than the hike of 2005; therefore, prompting the authorities to raise discount rate as a policy measure. While the public debt to GDP ratio has been on a declining trend since 2001, fiscal balances, budget and primary budget balances, are emerging as a source of concern for the last two years. Public debt as a percent to GDP was recorded at 86.13 percent in 2000, from where it came down to 55.61 percent in 2007. Primary budget balance remained in surplus along with reductions in budget deficits until 2004. However, these favorable developments started to reverse from 2005 onwards when primary budget balance went into deficit and the budget deficit also increased. Although with high GDP growth rates these fiscal imbalances appear to be sustainable, rising current account deficit in the last two years pose a threat to this perceived stability. It is encouraging to note that external debt to GDP ratio is declining consistently since 2002; from 46 percent in 2002 to 27 percent at the end of 2007. Similarly, other indicators such as burden of short term debt and liquid foreign exchange reserves with respect to financing of imports are at satisfactory levels. Along with the favorable movement of foreign exchange reserves, the real effective exchange rate depicted stability, especially in the last two years of 2006 and 2007. From 2000 to 2005, the current account balance to GDP ratio has remained positive mainly due to the shrinking of trade deficit during this time period. However, in the following three years (2005-2007), the situation reversed and current account balance started to deteriorate. During 2005, trade balance was recorded at -4.10 percent of GDP, which pushed current account deficit to increase by -1.40 percent in the same year. Similarly, the trade deficit of -6.82 percent of GDP caused further deterioration in current account deficit by -4.90 percent of GDP in 2007. Usually, in developing countries fiscal imbalances are considered as one of the most important factors of current account deterioration; this however is not the only factor in Pakistan as the growth in imports had a major contribution in this regard. The trade deficit which was only 0.4 percent of GDP in 2002 (U.S. $ 294 million) rose sharply to 6.8 percent of GDP (U.S. $ 9.9 billion) in 2007. There are no universally accepted threshold values for either fiscal balances or current account deficits that can guide in exactly determining the degree of susceptibility of a country to a crisis. Nonetheless, Pakistani fiscal and current account (especially, trade balance) balances in 2006 and 2007, when compared to previous few years, do raise concerns. Therefore, this calls for a detailed examination of the sustainability of Pakistani fiscal and external balances. Key Pakistan’s macroeconomic indicators (2002-2007)
2002 Inflation Growth rate Interest rate Fiscal Imbalances PublicDebt Current account External Debt
3.11 10.1 (8.2) -4.33 (1.60 )
83.05 (3.72) 3.90 (0.40) 46 (33.40 ) 6.48 (.48)
4.73 8.0 (4.1) -3.74 (1.15 )
75.16 (3.78) 4.90 (0.43) 40 (33.35 ) 11.85 (.99)
7.48 7.5 (1.7) -2.39 (1.08 )
67.89 (3.92) 1.80 (1.30) 34 (33.31 ) 11.45 (1.11)
8.96 7.9 (4.7) -3.30 (-1.14)
62.68 (4.16) -1.40 (-4.10) 31 (34.04) 9.63 (10.48)
6.61 9.0 (8.2) -4.22 (-0.84)
57.67 (4.46) -3.90 (-6.60) 28 (35.65)
7.02 9.5 (8.8) -4.29 (-1.25)
55.61 (4.93) -4.90 (-6.82) 27 (38.69) 10.86 (15.61)
12.0 (8.8) -5.39 (1.74)
86.13 (3.25) -0.29 (-1.90) 44 (32.19)
12.7 (10.3) -4.32 (2.03)
91.09 (3.76) 0.50 (-1.80) 45 (32.14)
International 1.84 reserves
Real Exchange rate
a/ growth in Consumer Price Index (CPI) b/ annual percentage change in real GDP c/ SBP Discount rate; figures in parenthesis are 6-month T-bill rate d/ budget deficit as percent GDP; figures in parenthesis are primary balance as percent GDP e/ public debt as percent GDP; figures in parenthesis are billions of rupees f/ current account balance as percent GDP; figures in parenthesis are trade balance as percent GDP g/ external debt as percent GDP; figures in parenthesis are millions of dollars h/ international reserves as percent GDP; figures in parenthesis are billions of dollars i/ real effective exchange rate (REER; a rise in the index indicates appreciation of rupee)
It is remarkable that from a situation of default and unsustainable fiscal and balance of payments deficit only a few years back, Pakistan has come out of the debt trap, balance of payments turned surplus1, and fiscal deficit has declined below 4 percent of GDP. However, sharp increases in the inflation rate, widening trade deficit and re-emergence of balance of payments deficit in the current year are quite worrisome. With the widening of the balance of payments deficit and the possibility that fiscal deficit may start rising as the government provides for the higher levels of public expenditure, would the debt problem not emerge once again? Bilquees (2003) has examined the growth of debt over the 1980-81 to 2002-03 period by de-composing the effect of primary deficit, interest rates and exchange rate adjustments. She argues that primary deficits are basic to the growth of debt. Higher government public expenditure compared to its resources leads to higher domestic as well as external borrowings. The external borrowing with limited repayment capacity results in exchange rate depreciation with consequent implications for the debt. The differential between interest rates and growth of GDP also have implications for the debt but in Pakistan it did not result in rising debt ratio because the interest rates have always remained lower than the growth rate. Since growth of debt is influenced by primary deficit, interest rates and the exchange rate adjustment, the present study examines the fiscal, monetary and exchange rate policies pursued since 1987-88 when Pakistan signed its first stabilization program with the IMF. The plan of the paper is as follows. After this introductory section, Fiscal, monetary policies and exchange rate policies are examined in section II, III and IV. Trends in debt and debt servicing are reviewed in section V. Main conclusions are summarized in section VI.
II: Fiscal Policy Unless fiscal deficit is financed through grants, it would result in rising public debt. However, the debt-GDP ratio would increase only if the fiscal deficit as a percentage of GDP exceeds the growth of GDP. In Pakistan, the total public debt is still rising but in recent years, the debt-GDP ratio has started declining. Since 1987-88, when the fiscal deficit had increased to 8.5 percent of GDP and Pakistan signed the first IMF Stabilization programs in 1987-88, she has been grappling with reducing the fiscal deficit. It is expected that the demand management policies in the
Director, Pakistan Institute of Development Economics (PIDE), Islamabad. Surplus in balance of payments has been equivalent to 3.9 percent of GDP, foreign exchange reserves exceeded $12.5 billion, growth of exports accelerated to 13.0 percent, workers' remittances increased to $ 3.9 billion, the average interest rates fell to around 7.5 percent, and inflation rate has been around 4.6 percent during 2003-04. Real sector of the economy has also shown improved performance during the year: GDP registered growth rate of 6.4 percent while the investment increased form 16.4 to 18.1 percent of GDP.
form of contraction fiscal and monetary policies would help in narrowing the investmentsavings and the balance of payments gap2. Therefore, each of the IMF programs signed since 1987-88 called for further reduction in the fiscal deficit, though without much success. Fiscal deficit until the late 1990s has been in almost all the years in excess of 6 percent of GDP. In 1999-2000 it was still 6.6 percent of GDP. It has gradually declined to 4.5 percent of GDP by 2002-03 and to 3.9 percent in 2003-04.3 While there has been primary deficit upto 1995-96, it turned surplus in later years. During 2001-02, primary surplus was 2.5 percent of GDP, however, since then it has declined to 1.3 percent.
The impact of fiscal deficit on the economy has been controversial. Keynesians maintain that stimulation of aggregate demand in the presence of excess capacity and unemployment through fiscal deficit results in higher levels of income and output. Neo-classicists believe that fiscal deficits have adverse implications for savings and growth. The Ricardians believe that fiscal deficits do not have any impact on growth. 3 The National Accounts base has been changed since 1999-2000. The fiscal deficit as per new base declined from 3.7 in 2002-03 to 2.4 percent in 2003-04.
Table-1: Budgetary Deficit in Pakistan (as percentage of GDP) Public Expenditures Total Tax Total Non- Interes Develo Budgeta Reven Revenu Develo t p- ment ry ues es p-ment Payme Deficits nt 1987-88 17.3 13.8 26.7 19.8 6.9 6.9 8.5 1990-91 16.9 1995-96 17.9 1998-99 15.9 1999-00 16.3 2000-01 16.2 2001-02 17.2 2002-03 17.7 2003-04 18.0 12.7 14.4 13.2 12.9 12.9 13.2 13.6 13.7 25.7 19.3 24.4 20.0 22.0 18.6 22.5 19.9 21.0 18.9 22.8 19.3 22.2 19.8 21.9 17.7 4.9 6.2 7.5 8.3 7.3 7.1 5.9 5.2 6.4 4.4 3.4 2.6 2.1 3.5 3.2 3.5 8.8 6.5 6.1 6.6 5.2 5.2 4.5 3.9 Prima ry Deficit 1.6 3.9 0.3 -1.4 -1.7 -2.1 -2.5 -1.4 -1.3
Source: Pakistan Economic Survey and Supplements, various issues and Annual Report of State Bank of Pakistan, 2003-04. A number of factors have been responsible for the decline in the fiscal deficit during 2002-03 and 2003-04. These include debt reprofiling, slow growth of public debt, decline in the interest rates, reduction in development expenditure, and an increase in the non-tax revenues.4 Whereas reduction in fiscal deficit is quite welcome, it needs to be underscored that it has been due to reduction in the public expenditure rather than an increase in resource mobilization. Tax-GDP ratio in 2003-04 is a little lower than in 198788, while total Revenue-GDP ratio shows slight improvement. However, public expenditure declined sharply from 26.7 to 21.9 percent. Whereas non-development expenditure has remained somewhat constant up to 2002-03, there has been sharp decline in development expenditure. The development expenditures help in improving physical infrastructure and social services such as primary education, basic health care, safe water and sanitation which in turn helps in the growth of output and employment generation. The declining level of public expenditure especially development expenditure, therefore, has serious implications for the economy. The public expenditure will have to be increased and unless there is resource mobilization, the fiscal deficit would start increasing once again. We may also note that though overall fiscal deficit has declined, the deficit on current account hardly shows any decline. With the rising interest rates both within the country and outside, increase in public expenditure, the instability in non-tax revenues, and the declining impact of the debt rescheduling on fiscal situation there is a need for a bolder strategy for reduction in
The tax-GDP ratio, however, has remained somewhat constant.
the fiscal deficit and the only viable solution for reduction in the fiscal deficit is resource mobilization by making the tax structure elastic. Whereas over the 1990s the direct tax structure was marred by withholding taxes that made most of such taxes essentially an indirect tax, the replacement of such taxes with the proper income taxes would help in improving the elasticity of the tax structure. Structural changes within the indirect taxes also hold promise for higher tax revenues. As the tariff rates have been reduced share of custom duties in total tax revenue has shown a declining trend. From 40.7 percent in 1987-88, the share declined to 10.4 percent in 2001-02, but increased to 12.7 percent in 2002-03 and further to 14.7 percent in 2003-04 because of increase in imports. Whereas share of excise duties has declined to just 7.4 percent that of sales taxes increased from just 9.3 percent in 1987-88 to 36.0 percent by 2003-04. The improved tax structure through better tax administration and widening the tax net would result in higher tax revenue. Table-2; Tax Structure of Pakistan (%age share of tax revenues) Years Direct Taxes 13.3 16.0 26.2 27.0 28.5 29.1 30.8 27.7 29.6 Indirect Taxes Total 86.7 84.0 73.8 73.0 72.3 75.8 69.4 72.3 70.4 Tariffs 40.7 38.9 29.1 20.1 15.2 14.7 10.0 12.5 14.7 Sales 9.3 13.0 16.3 17.6 28.8 34.8 34.9 35.6 36.0 Excise Duties 18.8 19.3 17.0 16.0 14.1 11.4 10.2 8.6 7.4
1987-88 1990-91 1995-96 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04
Source: Based on data derived from Pakistan Economic Survey, various issues. Whereas restructuring of CBR and improvements in tax administration was expected to result in higher tax revenues, growth of GDP especially in the large manufacturing sector has not been accompanied with a sharp increase in tax revenues. For example, in 2003-04, the nominal GDP grew at a rate of 13.2 percent and manufacturing output from where most of the indirect taxes are collected, grew at a rate of 21.7 percent, the tax revenues increased by just 8.7 percent. Moreover, as Table 3 shows, the tax revenues are not correlated with growth.
Table-3: Growth of Tax Revenues Year Percentage growth of federal tax revenue 10.9 3.7 9.2 8.7 16.3 8.7 Percentage growth of total tax revenue 10.1 3.8 8.9 8.3 16.3 9.5 Growth rate of GDP in nominal terms 9.8 6.5 9.7 5.7 9.5 13.2 Growth rate of large scale manufacturing in nominal terms 6.9 10.3 21.3 3.2 13.5 21.7
1998-99 1999-00 2000-01 2001-02 2002-03 2003-04
In view of the slow growth of revenues and need for higher public expenditures, the fiscal deficit can be kept in safe limits only if resource mobilization is pursued vigorously. III. Monetary Policy Fiscal deficit and money supply are interrelated. The pursuit of monetary policy is rather difficult when the financing of the fiscal deficit absorbs a large proportion of the increase in credit. Fortunately because of the decline in the fiscal deficit in recent years there is little demand by the public sector for bank credit5 and that has made it easier for the State Bank of Pakistan to meet the credit needs of the private sector at low interest rates without worrying too much about inflationary tendencies in the economy. For example in 1998-99 money supply was contained but credit to the private sector increased sharply. However in the next three years, credit demand of the private sector slackened due to various reasons resulting in excess liquidity with the banks. Money supply increased very sharply in the 2001-04 period, because of sharp increase in the foreign assets as the State Bank of Pakistan purchased foreign exchange from the banks and open market. Despite the sterilization money supply increased at rather high rates of 15.4, 18.0 and 19.4 percent in 2001-02, 2002-03 and 2003-04 percent respectively.
In some of the years, the government retired the bank debt.
Table-4: Growth Rate of Money Supply (Percent) Years 1987-88 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 Public Sector Budgetary Borrowing Support 17.3 13.3 8.4 -11.8 13.3 -7.1 3.7 -10.9 9.7 9.5 -13.6 7.9 -6.0 2.9 -9.9 12.5 Private Sector 13.4 13.8 17.1 3.2 8.2 2.5 16.1 30.1 Money Supply (M2) 12.2 14.5 6.2 9.4 9.0 15.4 18.0 19.6
Source: Pakistan Economic Survey, various issues. The increase in money supply did not result in a sharp reduction in the interest rates. The average interest rates on advances declined from 14 percent in 2001 to 7.5 percent by June 2004. Over the same period, call money rate had declined from 9.0 to 1.9 percent. The weighted average yield on treasury bills declined from 12.0 to less than 2.2 percent. Decline in interest rates positively impacted the fiscal situation. While the expansion in credit helped in reducing the interest rates, it could have pushed up the inflation rate. Surprisingly, despite high growth rate of money supply in 2001-02, 2002-03 and 2003-04, the inflation rates have been quite moderate. However, by March 2005, it had increased to double digit. Contraction of money supplies to control the inflation would push up the rate of interest. It would have serious implications for the fiscal deficit which would rise with high interest rates and in turn increase the debt once again. The rising interest rates would also impact the growth rates of GDP and investments. Table-5: Inflation Rates Period 1987-88 1996-97 1997-98 Consumer Index 6.3 11.8 7.8 Price Wholesale Index 10.0 13.0 6.6 Price GDP Deflator 9.6 13.3 7.7
1998-99 1999-00 2000-01 2001-02 2002-03 2003-04
5.7 3.6 4.4 3.5 3.1 4.6
6.3 1.8 6.2 2.1 5.6 7.9
5.9 2.8 7.8 2,5 4.1 6.8
Source: Pakistan Economic Survey, various issues. IV. Exchange Rate Policy The exchange rate is also a crucial variable in debt dynamics. Bilquees (2003) noted that in a few years, the entire increase in debt burden may be attributed to the exchange rate change. Because of the double digit inflation rates in the 1990s, Pakistan had to devalue her currency. However, she did not devalue enough to compensate for the increase in the relative inflation rate and resultantly, real exchange rate by 1997-98 had in fact appreciated by 8.7 percent. Over the 1999-2002 period, however, there has been real devaluation. Since then the Pak rupee has appreciated against the dollar though the currency has depreciated against other major currencies of the world. During 1998-99 when sanctions were imposed on Pakistan, both export and imports went down rather significantly. Whereas exports gradually increased and during 2002-03 it grew at a rate of 19.1 percent and in 2003-04 further by 13.8 percent, imports stagnated due to low levels of economic activity. However, both in 2002-03 and 2003-04 imports increased by 20.1 percent resulting in an increase in the trade deficit. Because of a sharp increase in workers’ remittances and decline in interest payments, the current account balance of payments in the years 2001-02, 2002-03 and 2003-04 turned surplus. During the first 9 months of the 2004-05 fiscal year the trade deficit has increased to $4.2 billion and the balance of payments has turned deficit. To the extent the increase in deficit reflects the increase in imports of machinery it is quite welcome. However, if most of the growth in imports does not add to the productive capacity it may be reflecting the diversion of domestic demand to imported goods resulting in higher external debt in the short, medium as well as long run. Table-6: Trends in Balance of Payments (Million $) Years Exports Imports Trade Balance 1987-88 4362 6919 2557 1995-96 8311 12015 3704 1998-99 7528 9613 2085 1999-00 8190 9602 1412 2000-01 8933 10202 1269 Remittances Current Account Deficit 2013 1682 1461 4575 1060 2429 983 1143 1087 513
2001-02 9140 2002-03 10889 2003-04 12395
9434 11333 13607
294 444 1212
2389 4237 3871
-1338 -3028 -1313
Source: Pakistan Economic Survey, various issues. Foreign exchange reserves lend stability of the exchange rate. Foreign exchange reserves in Pakistan have been traditionally low; and they rarely crossed $ 2 billion. Whenever the reserves fell, Pakistan had to devalue her currency. After the sanctions in 1998 the reserves had been hovering around $ 1 billion and with rather high debt servicing Pakistan was on the verge of default. However, in the post-2001 period, because of reduction in trade deficit, the sharp increase in workers remittances, deposit of overseas Pakistanis and the capital inflows, foreign exchange reserves have increased sharply. The foreign exchange reserves have crossed $12.5 billion of which around $ 10 billion are owned by the State Bank of Pakistan and the remaining are resident and nonresident accounts with commercial banks. Higher reserves resulting in stability of exchange rates have also helped Pakistan in the resolution of the debt problem. V: Trends in Debt and Debt Servicing The debt problem has been haunting Pakistani policy makers throughout the 1990s. Since the fiscal deficit despite some reduction until recently was much higher than the growth rate of GDP, the public debt continued to rise at a rapid rate. The public debt increased from Rs.538 billion in 1987-88 to Rs.3,077 billion in 1998-99 and further to Rs.3,783 billion by 2000-01 i.e. 79.8, 104.7 and 113.5 percent of GDP respectively. The internal debt increased from Rs.290.1 billion in 1987-88 to Rs.1392.5 billion in 1998-99 and further to Rs.1731 billion by 2000-01. Similarly, external obligations increased from Rs.247.9 billion in 1987/88, to 1614.4 billion in 1998-99, and to 2059.5 billion in 200001.Whereas public debt, internal or external debt is a problem, it is the external debt which has stronger bearings on the economy. The fact that the magnitude of total outstanding debt and even the per capita debt increased significantly and Pakistan found it difficult to finance the debt may suggest that the debt is beyond tolerable and sustainable levels. The present value of debt as a percentage of GDP shown in Table-8 indicates that Pakistan's debt is not all that heavy. It is not the debt burden that is excessive, it is the difficulty to finance the short term debt which has been a major problem. Table-7: Outstanding Total Debt as Percentage of GDP Country Pakistan Ethiopia Argentina Vietnam Debt as Percentage of GDP 2000 2002 45.0 45.0 52.0 63.0 56.0 66.0 36.0 35.0
Brazil Bangladesh India Sri Lanka Egypt Indonesia Philippines Morocco Jordan Turkey Thailand Malaysia Tunisia Kenya Nigeria
39.0 20.0 44.0 23.0 96.0 64.0 49.0 90.0 57.0 64.0 52.0 57.0 39.0 74.0
48.0 22.0 17.0 48.0 28.0 89.0 77.0 51.0 83.0 77.0 49.0 57.0 65.0 40.0 82.0
Source: World Development Report: 2003, 2004 and 2005. Another way of examining whether the debt has been in tolerable limits or not is to estimate the debt Laffer Curve. Choudhary and Anwar (2002) using the debt Laffer curve show that Pakistan's debt is not that high that the creditors could write off at least a part of the debt and would also gain in the process. The debt problem of Pakistan has been its lack of capacity- to finance debt servicing. Increasing reliance on short/mediumterm financing to meet external obligations in the 1990s resulted in a sharp increase in debt servicing. For example, in FY96/97, short/medium-term debt represented about 18 per cent of Pakistan's external liability and accounted for over 55 per cent of the debt servicing cost. The debt servicing accounted for as much as 62.1 percent of the total exports and 46.0 percent of total foreign exchange earnings in 1996-97 (see Table-8). Table-8: Profile of Domestic and External Debt (Rs. billion) 1997-98 Total Debt Servicing 278.3 Total interest payment 191.6 Domestic 160.1 Foreign 28.7 Explicit liabilities 2.8 Repayment of principal 86.7 Ratio of external debt servicing to Export earnings 55.4 Foreign exchange earnings 34.9 Ratio of total debt servicing to 1998-99 343.1 220.1 178.9 38.0 3.2 123.0 35.3 23.6 1999-2000 2000-01 353.9 256.8 206.3 44.9 5.6 97.1 36.5 23.4 325.0 237.1 178.8 50.5 7.8 87.9 37.4 23.3
Tax revenue Total revenue Total expenditure Current expenditure
78.4 64.8 43.9 52.5
87.8 73.2 53.0 62.7
87.2 65.9 47.6 55.0
68.9 57.0 49.5 49.3
Source: State Bank of Pakistan, Annual Report 2000-01. The Government appointed the Debt Reduction and Management Committee in early 2000 which submitted its report in March 2001 [Government of Pakistan (2001)]. The Report suggested revival of growth, reduction in future borrowing, bringing down the real cost of borrowing, divestiture of assets, improving the effectiveness of government expenditure, and improving the carrying capacity through growth in revenues, exports, remittances and other foreign receipts for resolution of the problem. It also came up with a short term strategy which called for rescheduling of $5.1 billion. While one can hardly disagree with the policy suggestions the Report failed to come out with concrete policy actions. Because of various reasons public debt has declined to 79.3 and 72.3 percent in 2002-03 and 2003-04 respectively. Following are some of the factors for the turn around: • • • Writing off some debt and converting some into debt-social sector spending swap. Pakistan got a debt relief amounting to $ 1495 from the USA; Receipt of grants as budget support; Rising remittances have improved the balance of payments situation and has allowed the government to pay back expensive loans and improve the liquidity situation; Appreciation of the rupee against the dollar has also meant a reduction in the foreign debt denominated in local currency; Smaller budget deficit; and Reduction in interest rates.
• • •
Table-9: Profile of Domestic and External Debt FY 99 FY OO 3,077. 3,336. 0 8 1,392. 1,578. 5 8 1,614. 1,682. 4 7 70.1 75.4 104.7 88.0 FY 01 FY 02 FY 03 3,884, 3,783. 3,824. 5 0 0 1,731. 1,717. 1,852. 0 9 4 2,059. 2,005. 1,927. 5 6 7 94.0 59.5 41.6 93.3 85.9 793 FY 04 3946. 3 1975. 4 1937. 5 33.4 72.3
Total Debt 1. Domestic Debt 2. External Debt 3. Explicit liabilitiesa As Percent of GDP Total Debt
Domestic Debt 47.4 41.6 External Debt 54.9 44.4 Explicit liabilities 2.4 2,0 Total Public Debt 343.1 366.3 Servicing Total Public Interest 220.1 269.2 Payments i. Domestic 178.9 1218,7 ii. Foreicn 38.0 44.9 iii. Explicit liabilities 3.2 5.6 b Repayment of Principal 123.0 97.1 Ratio of External Debt Servicing to Export Earnings 31.6 36.5 Foreign Exchange 23.6 23.4 Earnings Ratio of Total Public Debt Servicing to Tax revenue 87.8 90.3 Total revenue 73.2 71.5 Total expenditure 53.0 51.7 Current expenditure 62.7 58.5
41.6 49.5 2.3 340.3
39.0 45.6 1.4 431.2
38.4 40.0 0.9 304.7
36.2 35.5 0.6 337.2
254.4 279.2 241.7 226.0 195.4 51.3 7.8 85.9 32.7 20.4 77.1 61.5 47.4 52.7 212.5 61.1 5.6 164.9 36.7 21.7 90.2 71.2 53.8 63.4 189.0 49.2 3.5 63.4 22.8 12.6 55.1 42.5 33.8 37.8 182.0 41.0 3.0 111.3 32.5 18.8 55.2 42.2 34.7 42.9
Source: State Bank of Pakistan, Annual Report, 2002-03 and 2003-04. Since raising of loans help in alienating the resource constraint, the rising debt levels should not create problems if the loans were properly utilized. For example, if it is assumed that the entire capital inflows are used only for investment purposes, then the foreien aid on average would have been responsible for one-fifth of GDP growth. However the assumption may not be tenable if foreign capital inflows result in higher level of private and public consumption and as such the savings rate falls. For example, see Bhagwati (1970), Chaudhary and Hamid (1987), Griffin and Enos (1970), Mosley (1987) and Nabi and Hamid (1991). By regressing the savings rates against the foreign capital inflows along with other variables that affect savings behavior, it has been found that foreign capital inflows have entirely been used to finance consumption in Pakistan [See Kemal (1997). The increase in foreign capital has resulted in lowering savings by the same magnitude and as such foreign aid may have contributed almost nothing to growth. Siddiqui and Malik (2001) estimate directly the impact of debt on growth rates and argue that debt accumulation and growth has a non-linear relationship. Up to a certain level the impact is positive and beyond a threshold level the relationship turns negative. Why the loans are not properly utilized? There are at least four major reasons for improper use of loans, viz. the donor's agenda; corruption; capital flight; and the adverse impact of loans on domestic savings. Whereas the donor agencies play an important role in economic development by providing the requisite finances, they also influence the policies and agenda of the government through choice of projects and technology, programs, economic strategy and consequently the levels of efficiency, employment, poverty, and income distribution. That sovereignty is compromised has
been extensively analyzed. For example, see Corbo and Suh (1992), Jain and Bongorals (1994), Banuri, Khan, and Mahmood (1997), Kemal (1994), Killick (1995), Park (1995), Mcgillivary et al (1995), Morrissey (1995) Pasha (1995), Cameron (1995), Tetzlaff (1995), and Reiger (1995). Tying of aid to sources and to certain projects reduces the utility of aid and it may not generate sufficient output and exports for debt repayment. Corruption is widespread and a substantial part of the resources earmarked for development projects are misused [see World Bank (2001)]. Widespread corruption in Pakistan is well reflected in the large number of cases being investigated by the National Accountability Bureau. We may note that a part of the money obtained through corrupt practices is used in conspicuous consumption, while the remaining money leaves the country. Dornbusch (1985) and Ize and Ortiz (1986) argue that currency over-valuation, threat of devaluation and increasing domestic financial instability results in capital flight. While these are important issues in capital flight, there are many other motives that lead to capital flight. For example, corruption money may leave the country to avoid any accountability because the corrupt feel that such money is safer abroad. Similarly, domestic producers may use foreign resources to fund domestic investment and invest their own resources abroad even if the return is lower outside the country as long as they earn more than the cost of funds. Moreover, when implicit or explicit public guarantees create interdependence among private investors, a move by one borrower that increases the likelihood of its own default increases the expected tax obligations of other borrowers and by placing these funds abroad, they escape increased tax payment6. How the debt crisis impacts growth has been widely discussed in the literature [For example, see Williamson (1989), Ahmed and Summers (1992), Fishlow (1985), and Lustig (1999)]. Whenever the debt crisis assumes significant proportions, the resource inflows dry out and there is a negative transfer of resources from the debtor countries. The investment tends to fall as the debt rises beyond safe limits, investible resources fall due to a sharp increase in debt servicing, investors lose confidence, demand falls to low levels, interest rates start rising and there is a massive capital flight. Does the writing-off or rescheduling of debt resolve the debt problem? While it provides the breathing space, it hardly resolves the crisis. The debt crisis is not resolved until the debt situation is such that there is confidence in the country's ability to service its debt over time under a reasonable range of economic conditions, and the debt burden must not leave the debtor in a state of long term stagnancy [see Fisher (1987)]. The efficient and pragmatic resolution of the debt crisis as pointed by Carmicael (1999) is the one that stimulates investment and, through investment, economic growth; lowers protection; and reforms are instituted at both the macro economic level (especially fiscal restraint and sound management of exchange rates) and the microeconomic level (liberalization of markets, removal of distortions).
Eaton (1987) and Khan and Haque (1985) argue that there is an asymmetric risk of expropriation facing domestic and foreign investors. Domestic investors invest abroad and they finance their investments from borrowing abroad especially when the debt is guaranteed by the government.
The major concentration of the study is summarized below: Whereas Pakistan has been able to avoid the debt crisis the sharp increase in the inflation rate, widening of trade deficit and re-emergence of balance of payments is threatening the stability of the economy; The three main contributing factors to the increase in public debt are the primary fiscal deficit, interest rate-growth differential and exchange rate changes; Fiscal deficit until the late 1990s has been in excess of 6 percent of GDP but declined to 3.9 percent in 2003-04. Since 1998-99, there has been primary surplus though the surplus has shown a declining trend since 2001-02; The fiscal deficit has declined because of debt reprofiling, slow growth of public debt, decline in interest rates, reduction in development expenditure and an increase in nontax revenues; Since social and physical infrastructures need considerable improvements, the only viable solution for reduction in the fiscal deficit is resource mobilization by making the tax structure elastic; Tax revenues and growth do not seem to be correlated in Pakistan. Compared to nominal growth of 13.2 percent in GDP and 21.7 percent in manufacturing output, tax revenues increased by only 9.3 percent in 200304; Sharp increase in money supply has led to sharp reduction in the interest rates with positive implications for the fiscal deficit but it has generated inflation during the current year; Increase in foreign exchange reserves have helped in the stabilization of the rupee against the dollar and that has positively impacted the debt situation; Whereas external debt had risen to around $ 29 billion in 2000, the present value of debt compared to many countries shows that Pakistan's situation has not been all that bad. However, it was debt servicing that created the problems. The debt servicing accounted for as much as 62.1 percent of total exports and 46.0 percent of total foreign exchange earnings in 1996-97; The total debt has stabilized in the last couple of years and as a percentage of GDP the total debt has declined to 79.3 and 72.3 percent respectively in the last couple of years. A number of factors have been responsible for this turn around which include writing-off some debt and converting some into debt-social sector spending; grants for budgetary support; appreciation of the rupee against the dollar; smaller budget deficit, reduction in the interest rate, increase in remittances that improved the balance of payments situation and enabled the government to pay back the expensive loans; and The debt crisis emerges because the loans are not properly utilized and there are at least four major reasons for improper use of loans, viz. the donor's agenda; corruption; capital flight; and the adverse impact of loans on domestic savings.
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