Mar 9 - 15, 2009

Standard Chartered Analyst Asim reviewing the impact of global financial crisis evaluates that public debt saw an alarming increase in 2008, reversing the declining trend in the debt position seen over the previous 10 years. Total debt increased sharply to 56.1% of GDP at end-December 2008 from 52% of GDP in December 2007, reflecting large fiscal and current account deficits in 2008. Public debt had been declining steadily since 2000, falling from nearly 90% of GDP in 2000 to 52% in 2007. Higher debt increases the vulnerability of the economy to external shocks, particularly higher international commodity prices and a slowdown in private FX flows. In addition, higher debt servicing will leave the government less fiscal room to implement its public investment programme, weighing down long-term growth prospects.

Important disclosures can be found in the Disclosures Appendix.


The improvement in the debt position since 2000 was due to accelerating economic growth, consolidation of public spending, and wide-ranging structural reforms. In particular, the success of the privatisation programme, with 80% of state-owned banking assets sold off, and deregulation of the telecom and oil & gas sectors attracted higher non-debt creating private FX inflows. This helped the economy sustain higher growth and caused public debt to decline from 90% of GDP in 2000 to 52% in 2007. However, the unprecedented oil and commodity price shocks of 2008 resulted in a surge in the fiscal and current account deficits. Policy inaction, particularly a delay in passing on higher oil prices to domestic consumers, caused the fiscal deficit to rise to 7.4% of GDP in 2008 from 4.3% in 2007. Similarly, the inflated import bill caused the current account deficit to shoot up to 8.4% of GDP from 4.9% in 2007. Financing of the large twin deficits was the primary cause behind the rise in debt stock.


The biggest challenge for policy makers in 2008 was related to financing the large external deficit, which jumped up to USD 15.2bn from USD 8.3bn in 2007. This deficit had to be financed by drawing down official FX reserves; as a result, these reserves declined to USD 6.6bn by end-2008 from USD 13.4bn at end-2007. This resulted in the Pakistani rupee (PKR) weakening to 79.1 per USD by end-December 2008, a depreciation of 29% y/y. To support Pakistan's balance-of-payments position and shore up FX reserves, the authorities requested a USD 7.6bn IMF loan facility. In November 2008, Pakistan entered the IMF programme and received the first tranche of USD 3.1bn. This was the single biggest cause of the build-up in external debt, which increased to USD 50.8bn (29% of GDP) in 2008 from USD 43bn (25% of GDP) at the end of 2007. The other main contributor to rising external debt was USD2.3 bn in loans from international financial institutions (IFIs) for the public investment programme.


A debt sustainability analysis by the government and the IMF shows that Pakistan's debt position worsened significantly in 2008. External debt and liabilities (EDL) as a percentage of FX receipts (exports, services receipts, and private transfers) increased to 127.2% in 2008 from 121.6% in 2006, indicating that the stock of EDL is growing at a faster rate than foreign exchange earnings. EDL as a percentage of official FX reserves surged to 407.3% in 2008 from 267.5% in 2007, reflecting a deteriorating ability to meet external debt obligations. This indicates that Pakistan's external debt portfolio is highly vulnerable to shocks that might lead to a deterioration of the balance-of-payments position. This could include another spike in international commodity prices, a decline in exports, and a slowdown in FX inflows into Pakistan. There is a real risk that such shocks are in the pipeline given the collapse in external demand amid the global recession and the rapid slowdown of FX inflows into all emerging economies due to the turmoil in the international financial markets.


Debt servicing is a major headache leaving the government less room for critical investments in infrastructure and limiting the resources available for social-sector spending. Declining public investment in 2008 led to a slowdown in economic growth and, given Pakistan's large debt portfolio, will likely remain a drag on growth in the near term.

Matters have been made worse by the rapid depreciation of the PKR, which adds to the cost of servicing external debt payments, and high interest rates, which increase the cost of borrowing in the domestic market. Debt servicing increased to 4.7% of GDP in 2008, compared to 4.2% in 2007 and 3.1% in 2006. At the same time, public investment fell to 4% of GDP in 2008, from 4.9% in 2007 and 4.8% in 2006. This is extremely worrying given that private investment also declined to 17% of GDP in 2008 from 18% in 2007, primarily on account of a 500bps hike in interest rates during 2008. The slowdown in investment will have a negative impact on the economy. We expect growth to slow to 3% in 2009, compared to 5.8% in 2007.