DR. M.

Aslam Chaudhary
Professor of Economics
UOL
Introduction
 key determinant of the debt sustainability

 Debt sustainability and its main determinants.

Twin Deficits (Twin deficit hypothesis expressed

that an expansion in budget deficit will ground
for rise in current account deficit)
Domestic Debt is the amount of
money raised by the Government, in
local currency and from its own
residents. Generally, domestic
debt consists of two categories,
which are Bank and Non-Bank
borrowing.
External debt
The portion of a country's debt that
was borrowed from foreign lenders
including commercial banks,
governments or international
financial institutions.
 Debt sustainability is defined :
“Ability to meet current and future debt servicing obligations… without
debt rescheduling or accumulation of arrears ( amount overdue) and
without compromising growth” (IMF and World Bank).
CURRENT CONDITIONS
 Persistent Current account imbalance (It is defined as the sum of
the balance of trade (goods and services exports less imports), net
income from abroad and net current transfers. ... A country is said
to have a trade surplus if its exports exceed its imports, and a
trade deficit if its imports exceed its exports.) ……… important in
determining the external debt and debt servicing ratios.
 The current account deficit of 4 % to 5 %,UP TO (7%) of GDP, in
Pakistan
 External debt to GDP ratio from 39.8 %(1980) to 57.5 % (2000).
… 64% now, further ADD DOMESTIC DEBT THEN….?
 Trade to GDP ratio was stagnant round 12% to 14 % of GDP
….despite huge depreciation on of the rupee.
 (Pak high)
Methodology and data source
Two approaches :
The first is Traditional threshold debt ratios
approach.
The second is theoretical models;
derive debt sustainability conditions for the public and
eternal debt separately.
 I. Traditional threshold debt ratios
The debt stock and debt servicing as a ratio of selected
macroeconomic indicators. These ratios are compared
with the benchmark threshold debt sustainability
indicators recognized by international organizations.
Ratios used:
Ratio of public debt to GDP.
Ratio of public debt to revenues.
 Also ( Debt to F. exchange earnings; Debt% of exports)
Trad. threshold debt ratios approach
For External debt ratios are:
Ratio of external debt to GDP.
Ratio of External debt to foreign exchange
earnings.
Ratio of External debt to Export of goods
and services.
Thresholds for debt sustainability indicator
used by EU, common wealth are :
Fiscal deficit 3% of GDP
Public debt as 23% of GDP
Domestic debt as 20% of GDP and
App. II Theoretical model
-The Public debt and fiscal sustainability
conditions:
Gt- Rt + it B t-1= ∆ Bt + ∆Ht ………… 1
Budget Deficit Financing deficit
LHS shows components of budget deficit i.e. primary
deficit + nominal interest payments on public debt.

RHS shows the Sources of financing the fiscal gap

i.e B is public debt stock and “H” is money growth
through seignorage.
II. Theoretical model
 The second equations is
derived from the first by bt= (1+rt)/ bt-1 - st
method of accounting used
by IMF. In this equation
 “b” is the public debt to GDP (1+gt)
 The term (1+r/1+g) is
discount factor.
 g is the real economic When interest growth
growth, r is real interest rate
 “S” is the government surplus differential is positive (r>g)
which includes rate of growth the debt to GDP ratio is
of money, primary balance to Explosive debt dynamics ie.
GDP.
Discount factor is > 1.
If its reversed then the debt
is bearable.
The necessary and sufficient
conditions for public debt
sustainability
Necessary condition for debt to be sustainable is
when r is less than g, otherwise if this is reverse
then debt is unsustainable. r= INTERETST ON
DEBT g= Econ. GROWTH

The sufficient condition for debt sustainability is

primary surplus has to be positive . i.e
Necessary and sufficient
conditions for external debt
sustainability
 The necessary condition is when g>r external debt
is sustainable , otherwise the reverse of this means
that debt accumulation is unsustainable.
The sufficient condition is that current account
balance (CB) must be positive: only then the debt is
sustainable:
otherwise it will not be unsustainable.
Regarding the sustainability of public and
external debt using two approaches

•Debt threshold indicators approach

•Debt sustainability condition approach
 Public debt sustainability indicators
Public debt grew from 8.6 % in 1980 to 16% in 1990, then declined
to 1.1% in 2002. afterwards accelerated again in 2008 (19%)

Year 1980 1990 2000 2001 2002 2003 2004 2005 2006 2007 2008

Public 127 674 3266 3500 3540 3770 3979 4092 4069 4935 5901
debt
Rs BLn

Pub. 8.6 16 13.1 7.2 1.1* 6.5 5.5 2.8 9.2 10.4 19.4
debt Resch-
(growth eduled
%)
Public debt growth
20
18
16
14
12
10
public debt growth
8
6
4
2
0
1980 2000 2002 2004 2006 2008
 public debt as % of GDP
increased from 54.4% in 1980 to 79% in 1990 due to
decline in concessional loans & capital inflows;
primary imbalances grew ,
economic reforms initiated in 1990 and Debt to GDP
ratio reached to 102.8 % in 2000 , afterwards declined
years 1980 1990 2000 2001 2002 2003 2004 2005 2006 2007 2008

GDP 54.4 79.0 102. 102.3 97.6 93.8 86.9 74.6 70.3 67.9 68.5
(2005)
% 8

Reve- 335 412 615 654 572 537 523 484 415 380 394
nue
%
Debt servicing as % of GDP &
revenue
All the debt sustainability indicators increased
from (1980 to 1990) as a result of economic
reform program. Now further , debt increased
 Increase in shorter term expensive external debt
Unfunded debt domestically
But debt ratios reported a decline trend in 1 st half
of 2000s decade and started rising again in 2 nd
half of 2000s decade.
External debt growth
25
20
15
10
5
0 external debt growth
-5
-10
-15
-20
1980 2000 2002 2004 2006 2008
 External debt to GDP ratio was 40% in 1980 and 50% in
1990, it started to decline in 2001 and continued even
after 2005, remained stagnate in 2008
External debt to exports ratio declined to 196% in 2005
from 369% in 2000, it started rising again from 2008,
now over 250%
years 1980 1990 2000 2001 2002 2003 2004 2005 2006 2007 2008

Debt 39.4 48.7 57.4 51.1 54.9 51.0 44.8 36.8 33.5 32.2 32.3
to
GDP
ratio

Debt 329 306 369 292 287 258 232 196 169 173 174
to
export (20-15
s of 60%
G/S %)
Sustainability conditions
approach (SCA)
Results regarding sustainability of
the Public and external
Using SCA
public debt sustainability conditions
The necessary and sufficient conditions for debt sustainability were tested for
the period ( 1970- 2007)
necessary condition r<g , sufficient condition is S>O
The table showed public debt remained
unsustainable throughout the period under
consideration except for the early phase of 200s
decade
decade r G S r<g S>O conculsion

1970s -9.8 4.8 -5.2 r<g S<O Unsustainable

1980s -1.4 6.6 -3.6 r<g S<O Unsustainable

1990s -1.2 4.0 -1.2 r<g S<O Unsustainable

2000s 1.6 5.0 2.2 r<g S>O sustainable

FY 2007 -1.9 6.4 -0.4 r<g S<O Unsustainable
Factors important for external debt
sustainability
necessary condition r*<g, sufficient condition CB >O

decades R rate R Prima Conditions for outcome

of GDP ry debt sustainability
intere growt CAB
st (r*) h (g) % of
GDP
1970s -10.7 5.5 -4.1 r*<g Pcab<O unsustainable

1980s -3.5 7.1 -1.2 r*<g Pcab<O unsustainable

1990s -3.6 4.4 -1.1 r*<g Pcab<O unsustainable

2000s 0.9 4.7 4.5 r*<g Pcab>O sustainable

2005 -2.9 6.4 0.4 r*<g Pcab>O sustainable
Indicators
From the (1970-1990) current account remained (-ve)
due to
 Large trade deficit
 Slow exports growth

During the 1st half of 2000s

 Improved deficit
 GDP growth
 Decline in interest
 Stability of exchange rate
 Exogenous capital flows
 Rescheduling and restructuring of debt
All these factors led to the improved debt ratios, but deteriorated in
the 2nd half of 2000s decade
conclusion
The main conclusion drawn from the paper is that
the levels of public debt and external debt have been
remained far from debt sustainability levels

Persistent fiscal deficit and primary current account

imbalances are the main significant factors to the
debt sustainability issue
Results
results based upon the
Sustainable threshold indicator approach
Debt sustainability conditions approach
have shown that
Public and external debt have been remained
unsustainable throughout the decade of 1970s to
1990s
Debt situations improved in 1st half of 2000s decade
and deteriorated in 2nd half of decade
Critical Review
 The author did not provide any policy framework for the government
to improve its deteriorating debt burdens or in reducing the twin
deficits existing in the country. As pointed out by M. A Chaudhry 1988

 The author also completely neglected to take into account the impact
of conditionality’s imposed by international lending agencies like the
SAP structural adjustment programs by IMF. As these have adverse
effects for macroeconomic variables of the country as pointed out in
chapter 14, page 319 in Akbar Zaidi’s book(2005); Issues of Pakistan’s
economy.

 The author also uses selective components of both domestic and

external debt. In domestic debt the author included bank and non-
bank sources only and excluded non-guaranteed debt by the
government in external debt. The author fails to give any explanation of
using these selective components in the debt analysis.
 N0 policy recommendations. Why end up accumolating debt