EXTERNAL DEBT OF PAKISTAN

AROOJ ASGHAR
(feedback@pgeconomist.com)

Apr 2 - 8, 20
12

Pakistan's economy is characterized by inadequate internal capital formation due to vicious circle of low productivity, low income, and low savings; hence, it calls for technical and financial support from Mid East and Western countries to bridge the resource gap. Due to this, external debt has become one of the major sources of capital formation and for the financing of the development projects in the country.

The big chunk of outstanding external debt is classified as public and publically guaranteed debt and accounts for 76.6 per cent of the total outstanding external debt. Out of the remaining amount 15 per cent debt is owed to the IMF. Private non-guaranteed debt contributes 6.4 per cent to the stock of external debt and another two per cent contribution came from foreign exchange liabilities.

Total reserves (per cent of total external debt) were at 24.93, 30.39, 32.42 in 2009, 2010 and 2011 respectively. On other hand, total external debt servicing crossed USD10 billion mark during the first half of current fiscal 2011-12, which is also a record.

Like any other country, Pakistan also tries to use all the available and possible resources to raise funds for the implementation of its development plans. Principally, it has to utilize surplus revenues, tax revenues, seek external aids, and lastly borrow (both domestic and foreign).

Tax collection system is not very effective to avoid the evasions. As a result, the country has a poor tax to GDP ratio and government has no other means but to borrow money from the financial institution, minimize spending on the development of the economy, force State Bank to print more money or look for various sources to provide them with aid.

In last few years, external debt has grown rapidly. As per the State Bank, external debt was USD55bn, USD59bn, USD61bn on December 31st 2009, 2010 and 2011 respectively. The major reason for this rapid growth of indebtedness was the high deficits in the federal budgets.

As we all know, deficit in the federal budget originates when the federal revenues are less than federal expenditures. Every year the country needs more and more loans to make up its deficits, and so its debt goes on accumulating. The real issue is that it doesn't earn enough from the exports of textile and agri products to pay the expensive imported finished goods. The group of countries commonly called Friends of Pakistan, through international banks and government aids, fills the difference.

There are several reasons for taking external debt but, 1) deficit in the budgets, 2) capital flight, 3) foreign exchange problems and 4) excessive reliance on imported oil, are important.

Pakistan's foreign debt has two dimensions. On one hand, it is helpful in the development process and bridging up the gap between government expenditures and revenues which may not be covered by domestic savings while on the other, foreign debt is helping the economy to import the capital goods, machinery and technology for investment purposes which is sometimes impossible without the foreign aid, and necessary for the development plans.

Though current foreign reserves of USD16.44 billion are fairly high if we compare it with last years, yet they are not sufficient to fund the needs. Due to shortage of foreign exchange and high deficits in the balance of payments, it has borrowed from abroad loans to finance the projects and for meeting the needs.

External debt is denominated in multiple currencies but for accounting conventions, it is reported in equivalent US dollar. Thus weakening of Pak rupee against US dollar increases the foreign currency debt. Therefore, a stable rupee would help the country in paying off the foreign debt.

Economic managers say external debts are used to finance the projects in the country, which will in return increase the income of the people and correspondingly will increase the savings. Unfortunately, most of our external debts are being used on nonproductive projects, which depress the savings by increasing aggregate demand and consequently creating inflation which is already in double digit for quite sometime. In order to pay the expensive external debt, government has to increase the tax rates and reduce the state subsidies.

Federal government is generating revenues from direct and indirect taxes, custom duties, surcharge, foreign aid, grants, and local and foreign borrowings. Tax revenue collection is one of the most significant issues. Despite reforms in the last decade and a half, considerable distance has yet to be covered for making the tax system broad-based, productive, and efficient.

Increase of debt volume is not an issue however if indicators of external debt such as external debt to GDP ratio and debt service payments, deteriorate then it is alarming. Debt to GDP ratio is not in proportion to the increase in revenues and investment, which needs special attention.

In order to reduce state reliance of debt, government should involve private sector so that most of the projects can be developed in the private sector.

With an obvious lack of domestic capital, it is crucial that Pakistani companies attract foreign capital. This type of external borrowing is arranged under guarantees provided by the private sponsors whereas the government does not have any responsibility for such debt. The government's advantage is that this debt is not included in the statistics of the government external debt, while the capital imported by the private entities serves the national economy.

Pakistan has overall failed to improve its tax collection. Though various tax reforms have been introduced in the country, none of them yielded desired outcomes. However, similar reforms in the neighboring countries brought up a massive improvement in the tax revenue generation.

In order to increase the tax base, government should computerize the economy and should use computerized national identity card as national tax number. Focus should be on the increase in the number of taxpayers and not on the increase of the tax rates. In addition, government can raise additional taxes by covering up the mismanagement and good governance.

Pakistan is strategically placed and should utilize its foreign office is getting loan write-offs from its Mid East and Western allies. We have to co-operate with them but there is no harm in getting the right price.

In order to ensure sustainability, developing countries place limits on debt obligations usually linked with the level of capital inflows. Pakistan should also link its total external debt limit either with GDP, foreign exchange reserves, or foreign exchange earnings.

Prudent and efficient debt management is required not only to ensure that present debt levels are kept under control, but also manage future repayment obligations. There is no harm in taking loans but the problem is non-utilization of it effectively and appropriately. In addition, the government should utilize the private sector to the maximum limit so that the state could increase the tax collections and reduce its reliance on debt as well.