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Pakistan's External Debt Profile

  1. Capital Markets
  2. External debt profile
  3. Foreign Direct Investment
  4. Commercial Banks
  5. Privatization
  6. Leasing sector
  7. NetSol International
  8. Insurance

Debt servicing burden is both a cause and symptom of developmental and non-developmental expenditures

May 08 - 21, 2000

Dependence on international trade is determined by the size of the economy and the trade and investment policies a country pursues. Pakistan, being a medium-sized developing country has to rely on international trade to a large extent not only to meet her requirements of capital, intermediate and consumer goods but also to provide an important outlet to her surplus output. Unfortunately, the developed countries have put tariff and non-tariff barriers on Pakistan's exports which constrain potential for generating surpluses, where we have definite comparative advantages, and thereby the availability of foreign exchange. Despite the fact that Pakistan's foreign exchange earnings are not sufficient to finance her imports, Pakistan is pursuing a liberalized import policy in the belief that a freer trade policy enhances welfare of the masses of not only this country but all over the world. As a result of this Pakistan economy is experiencing a deficit in its external balance since independence. However, there are three occasions when the balance of trade recorded a surplus. The first was in 1947-48 when the import requirements of the newly born country were not yet well defined. Second, in 1950-51, caused by the Korean War boom leading to an increase in the international prices of Pakistan's major primary commodities. Third, it was the devaluation of Pakistan rupee in May 1972 and diversion of exports from former East Pakistan to foreign markets that helped achieve a surplus in 1972-73. Thus, the gap between exports earnings and import expenditures was to met through external borrowing.

Pakistan began to receive foreign economic assistance from July 1951, which continue to grow in volume thereafter. The substantial increase did take place in outstanding debt during the 1960s, especially during the second half of the decade when the rate of accumulation averaged about 24 per cent per annum. At the end of December 1969, the external debt of Pakistan amounted to $2.7 billion including the debt of Bangladesh while by December 1971, the figure rose to $ 3.6 billion of which $ 0.6 billion were subsequently taken off as these loans pertained to projects visibly located in Bangladesh. The rising trend of external debt accelerated further during the 1970s. The long term outstanding debt repayable in foreign exchange increased by more than double, from $ 3.0 billion in December 1971 to $ 6.3 billion in June 1977 which gives an average annual growth rate of about 11 per cent per annum. Although the average growth rate has slackened since 1977-78, about 6.5 per cent per annum, the indebtedness continued to rise. The disbursed and outstanding debt almost doubled over from 1980-81 to 1990-91 and grew at annual average rate of 6.2 per cent during this period.

Pakistan's accumulated disbursed and outstanding external debt (short, medium and long term) stood at $ 30.2 billion at the end of June 1999. External debt has grown at an average rate of 5.2 per cent per annum during the first nine years of the 1990s. Further breakdown of the period reveals that external debt has grown at an average annual rate of 9.3 per cent during 1990-91 to 1994-95. While the rate of accumulation slowed down to an average of almost one per cent per annum during 1995-96 to 1998-99.

The composition of assistance has also markedly changed over time. In the early years, a substantial portion of foreign assistance, which was in the shape of grant, and grant-like assistance, has steadily declined and substituted by hard term loans repayable in foreign currency with higher interest rates and shorter grace periods. The share of grant and grant-like assistance in the total commitments was 80 per cent during the First Five Year Plan period (1955-60) which dropped to 46 per cent during the Second Plan (1960-65), 31 per cent during the Third Plan (1965-70), 10 per cent during the Fourth Plan (1970-75) and 15 per cent during the non-plan period (1975-78). However, due to relief assistance for Afghan refugees, its share increased slightly to about 22 per cent during the Fifth Plan period (1978-83) and 23 per cent during the Sixth Plan period (1983-88). But it fell again to 16 per cent during Seventh Plan period (1988-93). The share of grants that was 9 per cent during 1996-97, further decreased to 6 per cent of total commitments in 1997-98, due to lesser availability from the donors.

The large accumulated amount of foreign debt has increased the liability of debt service payments manifold. The total debt service payments (principal plus interest) which were only $182 million in 1970-71 rose to $603 million in 1980-81. Debt service went up to $ 761 million in 1984-85, $1.11 billion in 1987-88, $ 1.232 billion in 1989-90. Debt servicing liabilities grew at annual average rate of 8.3 per cent during 1980-81 to 1990-91. The debt servicing liability exhibits a rising trend in 1990s, rising from $ 1.316 billion in 1990-91 to $ 2.577 billion in 1998-99, thus registering an average increase of 8.8 per cent per annum

Accumulation of external debt, higher costs of borrowing and lower maturity of loans are mainly responsible for steady increase in debt servicing liability. Debt servicing as a per centage of foreign exchange earnings has increased from 13.7 per cent in 1990-91 to 23.3 per cent in 1998-99. Furthermore, as a per centage of export earnings debt servicing has also increased during 1990s, increasing from 21.5 per cent in 1990-91 to 32 per cent in 1998-99 which is higher than the sustainable limits of 20-25 per cent. Debt servicing as a per centage of GDP has also rose from 2.9 per cent in 1990-91 to 3.9 per cent in 1998-99. What is disturbing to note is that almost one-third of exports earnings is now being consumed for debt servicing.

Several factors have contributed to this high rate of debt accumulation. The increase in volume of foreign assistance is due to a continuing shift in the composition of aid from grants and grant-like assistance to loans and credits repayable in foreign exchange. The extraordinary circumstances marking the world economy since 1973 have been the increase in oil prices, inflation and recession in the developed market economies. The combination of these factors led to a general deterioration in the external payments position of the non-oil exporting developing countries and forced many of them to borrow heavily or reduce their reserves. Along with other non-oil exporting developing countries, Pakistan also suffered from these international events of exceptional nature which imposed severe strains on its balance-of-payments position, hampered its development efforts and led to a marked increase in the volume of international indebtedness as well as its debt servicing liabilities.

While Pakistan's development performance was adversely affected by a hostile international environment, it also simultaneously faced certain domestic adversities, which aggravated the stresses and strains in its economy. First, agriculture suffered from extreme floods, droughts, Tarbela mishaps and pest attacks, which reduced our exportable surplus and resulted in higher imports. Production of wheat also suffered necessitating large imports of this commodity from abroad, partly under the long-term assistance programme and partly by short-term borrowing. In the first seven years of the 1970s, marked slowdown in growth of domestic product was one of the factors causing large balance of payments deficits necessitating an increase in foreign loans.

The reduction of dependence or more realistically, the curtailment of the increase in dependence to reasonable levels depends on a sound budgetary position, and one sound balance of payments position. Given the export performance of Pakistan, it is proposed that Pakistan should increase its exports, which can decrease its borrowing, by a substantial amount. For this purpose, there is a need for increasing not only the quantity of exports but also their range, because our export are limited mainly to cotton, rice, leather and carpets, etc. Hence, the growth of exports can also be achieved by exploring new avenues for exportable products. Thus, diversification of exports seems to be a rational policy target. Projects selected should be export oriented or for technological up-gradation to improve quality and competitiveness of Pakistan's exports abroad.

Reduction in imports is also expected to attenuate real debt. There are several areas of imports, which could be curtailed without any special disturbance. It may be noted, that Pakistan is predominantly an agricultural economy with more than 50 per cent of its labour force directly employed in agriculture, 70 per cent of population is dependent on this sector and 24 per cent of Pakistan's GDP is derived from agriculture. Nonetheless, she is importing wheat, edible oil, lentils and other agricultural products to meet the domestic demand for these commodities. Besides, several agricultural inputs like fertilizers, pesticides and machinery, etc. are also imported which can be substituted by domestic production. We have to keep the oil import bill within manageable limits. The short-term measures of containing the growth of demand for oil and oil products as well as medium to long term measures to set up the domestic production of oil, all have equal importance. As an immediate measure the natural gas could be substituted to take place petroleum whenever possible. As for as the commercial borrowing is concerned, it should be resorted to on a limited scale. Borrowing units should be allowed access to markets only for financing of imports requirement and not as a substitute for domestic financing either because external funds are cheaper or because they are readily available. By increasing export and reducing the imports simultaneously, Pakistan can substantially reduce its dependence on foreign loans.

The rapid growth of external debt and debt servicing burden is both a cause and symptom of developmental and non-developmental expenditures in recent years. The basic cause is the deteriorating rate of saving and the consequent widening of savings and investment gap and the way in which the gap is financed. Since the basic shortfall in saving is on government account, the widening gap between saving and investment has a counterpart in government's fiscal deficit. It is the widening fiscal deficits, which have been spilling into current account deficits necessitating increased external resource inflows, and partly resulting in increased internal liabilities of Government of Pakistan through internal borrowings from public and financial institution, mainly the State Bank of Pakistan. Thus, the reduction in current account deficit would require corresponding reduction in fiscal deficits, adoption of measures to stimulate savings and for their effective and efficient use. Reducing budget deficits will help bring down rates of monetary and credit expansion and will help to curb inflationary pressures. Failure to progress in inflationary front is one of the most disturbing economic features of Pakistan economy. This failure has hindered the task of reviving investment and hence improving resource allocation. Better price stability, accompanied by realistic interest rates, could unlock savings that are presently in unproductive forms.

The vicious circle of larger fiscal deficits, larger debts — both external and internal, larger debt service payments, larger balance of payments deficit, increase in money supply, consequent inflation, continuous depreciation of rupee to maintain competitiveness of exports in the face of internal inflation has become almost a built in feature of the financial scenario in Pakistan in recent years. We have to break the back of the vicious cycle through sheer dent of fiscal discipline, lesser borrowings, both internal and external, control of inflation by having tight control over money supply. It is recommended that it is high time that Pakistan realize this disease now rather than wait until it spread across the economy.

The author is lecturer at the Department of Economics, University of Karachi, Karachi.