Feb 1 - 7, 2010

Like many other countries of the world, Pakistan has accumulated large external debt. Ordinarily, external borrowing is ought to accelerate economic growth especially when domestic financial resources are inadequate and need to be supplemented with funds from abroad. The external debt also has a dark side. Foreign debt does not remain a blessing after it is accumulated beyond a certain limit.

In fact, too much of debt can dampen growth by hampering investment and productivity growth. The obvious reason is that when greater percentages of reserves (foreign currency) are consumed in meeting debt service, creditworthiness dithers away causing reduction in access to external financial resources. It is known that increase in external debt is invariably accompanied by an increase in the debt-service obligation, which has unfavorable implications for economic growth.

Increasing levels of domestic and external debts are not good for any country and its future after 62 years of its independence Pakistan could not yet achieve a desirable level of growth mainly due to paucity of resources and their mismanagement. To meet the increasing current and development expenditure the country needs to borrow heavily. Pakistan's national debt burden after declined to 58 per cent of GDP in FY07 is again showing a rising trend. It has increased to 61.2 percent of GDP in FY09. Pakistan's total domestic debt has increased by a big amount of Rs.1250 billion in two years, although as per cent of GDP it slightly declined to 29.4 per cent in June 2009 from 30 per cent in June 2007. However, its external outstanding debt is showing sharp increase. From June 2007 to June 2009 Pakistan's external debt and liabilities have increased by $12.5 billion (31.8 per cent of GDP). If all the loans which are in the pipelines including $11.3 billion from the IMF are added Pakistan's outstanding external debt will swell to over $70 billion in the near future.

The International Monetary Fund (IMF) has projected an alarming rise in Pakistan's external debt making it to touch $75 billion by the fiscal year 2015-16. According to the IMF's staff report released recently, Islamabad's external debt would shoot up to $57.417 billion by end 2009-10, $64.607 billion by 2010-11, $68.894 billion by 2011-12, $70.955 billion by 2012-13, and $74,161 billion by 2015-16.

The public and publicly guaranteed debt (including the IMF) would jump to $70.437 billion by 2015-16 while it was projected that the private sector debt from external avenues would remain at the level of $3.724 billion by 2015-16. Pakistan's total external debt may touch $57.417 billion by end 2009-10 out of which public and publicly guaranteed external debt would touch $53.947 billion, while, private sector debt was projected to reach at $3.470 billion.

Pakistan's medium and long term debt would stand at $44.102 billion during the end of the ongoing fiscal year out of which multilateral lenders' debts would be $24.686 billion while bilateral lenders' debts would be $17.888 billion. The debt amount from the ADB would stand at $11.627 billion and World Bank $12.440 billion. The IMF's loan will increase to $9.322 billion by end 2009-10.

It has been evident for some time that Pakistan's debt burden is extremely bloated. The danger of external debt default first emerged in 1996 towards the end of the second Benazir government. Imposition of economic sanctions by the Western countries following Pakistan's adventurous nuclear explosion in mid-1998 made the country to freeze the foreign currency deposits, a major source of balance of payments financing, and endured technical default on external debt.

Following an agreement with the IMF in January 1999, Paris and London Clubs provided substantial debt relief to Pakistan in the form of rescheduling of debt payments due in 1998-99, 1999-2000 and the first half of 2000-1. Despite debt relief, the burden of external debt remained extremely heavy and the danger of default did not disappear.

There has not been much systematic works on debt issues i.e. the nature of debt problem, the root causes of the debt buildups and the consequences of debt overhang for the economy. The present government needs both reasonably precise targets for debt reduction and a clear understanding of the policy elements or variables which will assist it in the attainment of these targets. If the previous government had had debt reduction goals and a strategy to achieve them, it did not share it with the public.

The difference between the problem of external debt and the problem of public or government debt often creates confusion. As a matter of fact, Pakistan has both of these debt problems. The focus must be on both aspects because it is not the debt per se that matters but the ability to service it.

The servicing of public debt poses different kind of issues as compared to servicing of external debt (including public and publicly guaranteed debts) which imposes a burden on the balance of payments because interest payments and repayment obligations become a first charge on future foreign exchange earnings.

The expected growth of budgetary revenues is of central importance for handling public debt while export earnings growth is often critical for keeping the external debt burden under control. The interest rate on borrowing is an important variable for all kinds of debt. But there is one critical difference at least between domestic portion of public debt and external debt (both public and private). Countries have relatively little control on the nominal or the real interest rate charged to them on borrowing abroad. But domestic interest rates, both nominal and real, can be manipulated by monetary authorities. Thus, national debt issues need to be analyzed from the differing perspectives of fiscal and monetary policies and balance of payments management.

There are of course strong overlaps between public and external debts in Pakistan. Most of the external debts are either public or publicly guaranteed debts. Pakistan private sector does not have large liabilities, either short term or long term, to foreigners other than those guaranteed by the government. Inflationary financing of budget deficits not only enlarges balance of payments deficits but also exerts a downward pressure on the external value of the currency. The exchange rate changes, in turn, can significantly change the burden of public debt; devaluation increases the amount of external debt expressed in local currency and increases the domestic costs of servicing foreign debts.

Borrowing domestically or abroad is a normal, indeed necessary part, of economic activity. Sound debt management, like good economic management in general, is more of an art than a science. That Pakistan's foreign debt problem has become even more serious than the domestic debt problem. Due to near stagnation or decline of exports during the past few years, the burden of debt in relation to exports of goods and services including remittances, a major variable determining the ability to service external debt, has grown sharply. The ratio of outstanding debt to exports is disappointing and is quite high.

In the near term, say over the next three to four years, Pakistan will have to live with the macroeconomic consequences of the heavy debt. It will imply abiding by the painful conditionalities of the World Bank and IMF and managing the economy with limited growth in investment and imports. The foreign exchange constraint will make it difficult to stage a quick recovery in economic growth, urgently needed to create jobs and reverse the trend towards increase in the incidence of poverty.


Instead of turning its back on the international community, Pakistan needs to demonstrate clearly better macroeconomic management during the next three to four years. This will require not only living with the resource constraints but also expanding the base of government revenues and exports, reducing or eliminating the excess of current government expenditures over revenues, improving the quality of resource use in the public sector. Better governance and good economic management could create conditions for justifying additional debt relief or even debt forgiveness.


Continued fiscal adjustment should be the central pillar of better macroeconomic management. But how this fiscal adjustment is achieved will be critically important for long term growth as well as equity in the society. That the government has been borrowing for current consumption for more than a decade is a root cause of our financial difficulties and a key factor in the low rate of domestic savings. The objective of fiscal policy should be not only to reduce the deficit further but also to transform negative government saving. If this can be achieved, it will make a dramatic contribution to raising the domestic saving rate directly as well as indirectly by increasing confidence in the currency, reducing the need for frequent devaluations and discouraging capital flight.


Pakistan needs urgently not only to recover the ground lost in revenues over the last few years but to generate revenue surpluses to fund neglected development spending. No doubt there is a great deal of waste in government and substantial downsizing is warranted. But on the other hand, public pay has been declining, social programs are seriously under funded, and maintenance of roads, buildings and irrigation works has been greatly neglected.


In Pakistan economic growth droops because there is insufficient investment in human and physical capital and the quality of public spending is deteriorated either because there is unabated leakage and corruption or spending is not focused on high economic and social return projects. This means that, apart from reducing the leakages from the system due to corruption, hard investment choices will have to be made in all sectors.


The most promising avenue of reducing the outstanding debt is the allocation of the large part of the privatization proceeds for the retirement of debt. But privatization process has moved very slowly. It needs to be accelerated for the sake of improving efficiency and transparency in the economy. More importantly, there are substantial public sector liabilities which are likely to materialize as budgetary obligations and will add to the debt thus offsetting the whole or part of the relief coming from privatization proceeds.


If the amount of outstanding debt cannot be reduced quickly, can the interest costs be reduced? Pakistan has no control on the level of international inflation and real devaluation is necessary to remedy the structural weakness in the balance of payments. Lower domestic inflation is desirable and has resulted from efforts to reduce the budget deficit and limit monetary expansion.

Pakistan's exports are suffering because export structure is weak and still heavily dependent on cotton based products. Extremely liberal incentives were given to relatively low value exports e.g. cotton yarn and as a result export diversification to relatively new and dynamic areas such as electronics and software did not take place. Exports are also hampered by the low level of human development and apathy towards education spending. The structural problems in exports need to be tackled but in the short run exchange rate adjustments may be the only way to increase the international competitiveness of products. Some further real devaluation may be necessary though it increases public debt burden. It will also improve the incentives for import substitution especially in wheat, and edible oils where large import deficits have persisted notwithstanding good agricultural potential in these crops.

Increasing levels of domestic and external debts are not good for any country and its future generation and their welfare unless these costly inflows are surpassed by visible benefits. Pakistan is already making huge repayments in the shape of principal amount and interests. For example, Pakistan paid about Rs.624 billion as interest to its domestic lenders while $4.345 billion was paid as principal cum interest to its foreign lenders in FY09. The external debt servicing as per cent of GDP has increased from 1.92 per cent in FY07 to 2.62 per cent in FY09. This ratio is not good and sustainable in future and should not be allowed to increase further. Pakistan can create a safe exit out of the menacing debt trap by increasing its indigenous resources, for which there exist huge reservoirs in the shape of its human capital, unexploited mineral deposits, hydropower potential, and huge agricultural and industrial potentials.

Sound public debt management supports macroeconomic stability and economic growth. Debt management should take advantage of favorable economic conditions to strengthen the technical and institutional capacity in managing public debt. In order to sustain and build on its existing achievements, Pakistan needs to deepen its structural reforms to improve the domestic investment environment, external competitiveness, sustain macroeconomic stability, and maintain political stability. Reforms that improve a country's creditworthiness and investment climate are important for improving domestic savings and investment, attracting FDI, and diversifying the financing sources. FDI is especially important because it not only brings in finance, but also contributes to technology transfer and improved management know-how.