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Pakistan's debt problem

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Nov 15 - 21, 1999

The 15th annual meeting of the Pakistan Institute of Development Economics provided a most useful forum for detailed discussion on the economic crises facing Pakistan, its history, causes and remedies — by top economic experts both based in the country and outside which will help our new economic managers to evolve a better strategy for the future. The 4 day conference which was attended by a cross section of economic experts ended in Islamabad on Monday.

Top ranking economists, bankers and financial experts read papers on different aspects of Pakistan economy such as rising budget deficits, declining exports and rising trade deficits, rising burden of domestic and foreign debts, privatization, neglect of agriculture sector, inconsistency in economic policies and good governance. Reading of every paper was followed by a lively question answer session which sifted out the main substance of the subject.

Dr. Pervez Hassan, former Chief economist of the World Bank, presented a comprehensive case study on "Pakistan's Debt Problem: It's changing nature and growing gravity." Pakistan is now a severely indebted country. Its public debt exceeds 95 per cent of GDP and 600 per cent of annual revenues, pointed out Dr. Hassan, detailing that external debt $ 35 billion stood at 350 per cent of annual foreign exchange earnings of the country.

All borrowing decisions were ad hoc in the past. The institutional capacity to monitor debt levels, analyse debt management issues and give advice on annual borrowing plans has been almost non-existent. "The new economic team should rectify this and set up a high-level "Debt Bureau" either in the Ministry of Finance or the State Bank to undertake the debt management functions, " he suggested.

Despite substantial debt relief and some debt reduction from the Paris and London Clubs totalling nearly US $ 8 billion the foreign exchange situation remains very difficult. He said that exceptional financing from the International Monetary Fund (IMF) the World Bank and other sources would continue to be needed at least in the next three years.

The debt burden was made much worse by the inability or unwillingness of elected leaders to reduce the fiscal deficit significantly. Real revenue growth during the period from 1996-99 has remained zero per cent per annum. Fiscal deficit as a percentage of GDP remained at 6.1 per cent on an average in the same period. These and other developments resulted in the rapid increase of implied real interest rate on debt from 3.5 per cent of 1988-96 to 6.5 per cent in 1996-99, on an average.

Stagnation or fall in exports and revenues, coupled with a quantum jump in external debt in the total public debt composition, had created a vicious debt-trap. Pakistan's total public debt as a percentage of revenues was 423 per cent in 1976-77 that had gone up to 604 per cent in 1998-99. As a result, cost of interest payments had also jumped up from 32.9 per cent in 1992-93 to 42.6 per cent in 1998-99. The debt is now driven largely by interest rate costs, observed Dr. Pervez Hassan. He stated that it was no t surprising that the debt indicators, which relate to debt or debt service to revenues, have shown much greater deterioration in the 1990s than in the 1980s. Thus real debt has continued to grow even though the primary fiscal balance is now in surplus. "Pakistan's foreign debt problem has become even more serious than its domestic debt problem that was reflected in the near default and subsequent rescheduling of external debt. Pakistan's debt crisis was essentially triggered by the unsustainability of the level of the current account balance of payments deficits and the pattern of their financing. ; During the eight years 1991-98, Pakistan ran current account balance of payments deficit of over US $ 28 billion, or on an average of 5.5 per cent of GDP.

This level of growth is not sustainable for a decade, even with a rapid expansion of exports. The growth of exports and remittances has in fact slowed down markedly in the first half of the 1990s and then stagnated.

The alarm bells on the external debt, however, did not ring in this period partly because balance of payments financing needs were being taken care of by the short-term foreign currency deposits, volatile portfolio investment and fixed cost direct foreign investment in the power sector.

Dr. Hassan said that debt problem cannot be separated from broader issues of economic strategy and management, notably trend in savings, exports and government revenues and quality of public resource use. In the near terms, say over the next two to three years, he said, Pakistan will have to live with the macro-economic consequences of the heavy debt.

Professor Paul P Streeten of Boston University USA, speaking on the philosophy and rationale of Privatization said, the Privatization without the right regulatory framework is bound to fail. Certain conditions have to be met to make privatisation a success. In addition to the need for a capital market there must be a competitive environment, so that public inefficiency is not just replaced by private inefficiency; or if a monopoly is inevitable, it should be regulated.

He said the privatization takes two forms. It can consist in transferring previously state-owned enterprise into private ownership, control and management; and encouraging the growth of new, normally initially small private enterprises. The reason for privatization, he said, is the inefficiency of many public enterprises, and the heavy drain on public revenues, their subsidies constitute.

An additional benefit can be the absorption of the liquidity overhang in many ex-socialist countries, if shares in the enterprise are sold and the receipts are not spent. In this way, Mr. Paul said, inflationary pressure can be reduced. But, he underlined, the aim should not be to maximise receipts from the sale of assets, but rather to encourage competition and to harness private initiative.

To corroborate his point on a right regulatory framework to make the privatization a success, Streeten said the premature freeing of prices in Russia led to vast price increase. This did not lead to more production because "protection rackets kept out new entrants and skimmed off large profits".

For successful privatization there must be training facilities for the new entrepreneurs and she workers, he further pointed out. There must be a legal framework for property rights. He said it is desirable that there should be a political consensus on privatization which in turn presupposes transparency of proceedings and credibility of policies.

Speaking on "institution of restraint (missing element in governance in Pakistan" Dr. Ishrat Hussain Director World Bank, said, the existing institutions can effectively check and minimise corruption and misgovernance, provided these are strengthened and given the autonomy they are invested with. The institutions, apart from the judiciary, are Parliamentary Committees, and Public Accounts Committee, Auditor General, Ombudsman, Public Service Commission, State Bank of Pakistan, Federal Election Commission and Securities and Exchange Commission of Pakistan.

He said that judiciary basically provided protection of human rights, security of life and property and contract enforcement. Parliamentary Committees and Public Accounts Committee check misuse and abuse of discretionary powers of the executive; Auditor General detects and report financial irregularities in public accounts. Ombudsman redresses grievance of citizens against excesses of public servants; Public Service Commission ensures transparency in appointments and promotion of civil services; State Bank undertakes probity, supervision and regulation of the financial institutions; Federal Election Commission screens candidates for elected office on the basis of integrity and securities and Exchange Commission of Pakistan ensures high standards of the corporate sector.

Dr. Ishrat Hussain observed "We have become one of the most corrupt nations. Poor pay structure, nepotism, the phenomenon of speed money, and the willingness of clients to bribe, are the principal causes of corruption." He quoted a bank study of over 200 small, medium and large business firms, conducted in 1995. This survey found 78 per cent firms had bribed public officials, mainly in the income tax, labour, customs and excise sales tax departments. A similar survey of 6,020 rural households carried out in 1996-97 revealed that 95 recipients of loans from banks out of 219 had paid bribes in exchange for loan approval. The average amount paid was 3.5 per cent of the loan amount.

According to him independence and strengthening of these institutions could revitalise the society with the cooperation of active civil society organisation and free press.

Elaborating on these pillars of good governance, Dr.Ishrat Hussain said that the Parliamentary Committees must acquire some teeth. The recent work of the PAC shows that timely deliberations and follow up action are of essence if the committees acquire some power. All procurement contracts above a certain financial limit, all fiscal exemptions and concessions, modification to the SROs should be placed before it. The proceedings of the committees should be open to the public and media. The temptation of committee members is to harass or intimidate the officials or get involved in macro management is a very strong tendency under the present political culture. If this continues, the committee will be more of a nuisance than agent of good governance.

State Bank of Pakistan being independent and autonomous can provide guarantees against excesses and irresponsible action of the politicians and bureaucrats in economic management. The federal and provincial governments can be guarded in their spending decisions if the bank refuses to honour the cheques beyond the given ways and means limits. At the same time, the regulatory and supervision functions act as safeguard against possible malpractices in the award of credit and recovery of loans.

Admiral (Retd) M Fazil Janjua, formerly minister for food, agriculture and co-operatives, said that if an economy has to be improved the focus should be on the strategy for future and role of public and private sector in the agriculture sector. The farmers should be given incentives and as the price of the agriculture inputs had increased there was a need to provide substantial support prices to the farmers.

Rashid Faruqee, Principal Economist, the World Bank Resident Mission in Bangladesh, in his paper reviewed the past performance of the agriculture sector of Pakistan and suggested the need for strategic reforms in agriculture sector. He said that in the past there were many constraints which effected the agricultural growth, such as human resources constraints, poor rural infrastructure and weakness of research and extension system.

While suggesting the future strategy for agriculture sector in Pakistan, Faruqee said the role of both the private and public sectors should be reorganized, irrigation crisis directly addressed and the distortion in line market corrected.