Feb 1 - 7, 2010

The massive borrowing by Pakistan over the last couple of years has once again plunged it into the debt trap. It may be good that the donors have been more than kind in extending the credit but the point of concern is that the economic managers have not worked out any repayment strategy as yet. The prevailing situation raises the fears that the country will be forced to borrow more for debt servicing.

Pakistan's debt can be segregated into two categories internal and external. Historically, domestic debt was acquired to meet the budget deficit but lately foreign debt has also been used to meet the current outlays.

How the debt crisis impacts growth has been widely discussed at various forums and the consensus is that 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.

Experts also say that debt provides the breathing space but it hardly resolves the crisis. The debt crisis is not resolved until the debt situation is such that there is the country's ability to service 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.

The efficient and pragmatic resolution of the debt crisis is the one that stimulates investment and economic growth ensues. In addition, 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).

Pakistan did face serious crises in the past and succeeded in averting those with the timely assistance of multilateral donors. However, it could not evade sharp rise in inflation rate, widening of trade deficit and re-emergence of balance of payments crisis impairing stability of the economy. The three main contributing factors to the increase in debt have been primary fiscal deficit, interest rate-growth differential and exchange rate changes.

The fiscal deficit declined during Musharraf era because of debt reprofiling, slow growth of public debt, decline in interest rates, reduction in development expenditures and an increase in non-tax revenue.

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. As against nominal growth of 13.2% in GDP and 21.7% in manufacturing output, tax revenues increased by only 9.3% during 2003-04.

Increase in foreign exchange reserves helped the stabilization of the rupee against the dollar and also positively impacted the debt situation during Musharraf era but are not yielding the same benefits now.

Another point worth noting is that 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 creates many problems.

Debt became sustainable in the recent past. A number of factors has been responsible for this turnaround which included some debts forgiveness and conversion of 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.

The debt crisis emerges because the loans are not properly utilized and there are at least four major reasons for improper use of loans: 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.

Corruption becomes widespread and a substantial part of the resources earmarked for development projects have been often misused. Widespread corruption in Pakistan is often reflected in the large number of cases being investigated by the National Accountability Bureau. Part of the money obtained through corrupt practices is often used in conspicuous consumption, while the remaining money leaves the country.

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 of the feeling 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.

It is necessary to point out that the government constituted a Debt Reduction and Management Committee in early 2000 which submitted its report in March 2001. The report suggested revival of growth, reduction in future borrowing, cutback in 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. While one can hardly disagree with the policy suggestions the report failed to come out with concrete policy actions.

It is true that recent substantial borrowing provides some breathing space. However, the real solution is trade not aid. There is urgent need for boosting exports and containing imports. The upcoming industrial policy must offer incentives for establishing new productive facilities. Tax revenue cannot be increased without withdrawing exemptions.


All offices of SBP Banking Services Corporation have started issuing new Rs 500 Banknote with an Optical Variable Ink (OVI) Feature. The new Rs 500 banknote with OVI feature bears the signature of Syed Salim Raza, Governor, State Bank of Pakistan.

The launching of Rs 500 banknote with OVI feature is part of SBP's continuous efforts to improve the security, durability and aesthetic quality of banknotes.

The Optical Variable Ink (OVI) design appears at the obverse right side as the crescent and five-pointed star printed with the surrounded design of Intaglio Optical Variable Ink which changes colour from green to magenta and vice versa when Rs 500 banknote is viewed from different angles.

The introduction of OVI feature in Rs 500 banknote distinguishes it from the new design banknote of the same denomination launched on 11th November 2006.

The old and new design Rs 500 banknotes will, however, continue to remain legal tender.