GOVERNMENT BORROWINGS

DEBT TO GDP RATIO NEEDS IMPROVEMENT

AROOJ ASGHAR
(feedback@pgeconomist.com)

July 16 - 22, 20
12

Budget deficit and it's financing in Pakistan, like in many other developing countries, are very important parameters for analyzing monetary effect as well as the fiscal effect in the country's overall economic development. Many industrialized countries face similar long-term budgetary challenges like Pakistan and have run persistently large budget deficits in recent years. These large and persistent budget deficits have generated considerable concern as it reduces growth and could lead to a crisis if continues for long or become too large.

Pakistan recorded an average Government Debt to GDP of 60.10 per cent in 2011. Historically, from 1994 until 2011, Pakistan government Debt to GDP averaged 70.62 per cent reaching an all time high of 87.9 per cent in December 2001 and a record low of 54.90 per cent in December 2007. In a very recent special performance audit report on Fiscal Responsibility and Debt Limitation Act 2005 revealed that the government has missed all core objectives enshrined in the Act. Total debt and liabilities crossed Rs12 trillion a year ago compared to Rs6.5 trillion when the government took over. Domestic debt, which was at Rs3.9 trillion, rose to Rs7.5 trillion in May 2012. The State Bank of Pakistan has recently reported that the central government borrowed Rs1.28 trillion to finance the budget deficit during fiscal year 2011-12. In 2008, when the current government came into power, state borrowing stood at Rs519.9 billion.

The Debt to GDP ratio improved from 60 per cent to 59.3 per cent at the end of June 2011. This ratio has improved further to 55.7 per cent of the GDP by the end of November 2011 and it is expected that debt to GDP ratio will be around 59 per cent by the end of fiscal year 2011-12.

The main objective of fiscal policy in Pakistan is to enhance the effectiveness of public expenditure by channeling resources to the appropriate direction and attain faster growth and poverty reduction by mobilizing larger amount of revenue. In the wake of persistent saving-investment gap, export-import gap, and fiscal deficit, a prudent public debt management is an essential issue for sustained macro stability of Pakistan.

The issue of public debt and debt sustainability has long been a concern for policy makers of both fiscal and monetary authority in Pakistan. High public debt stems from persistent fiscal deficit and has a significant negative effect on economic activity. It leads to high taxes and puts upward pressure on real interest rates, which may crowd out private investment. As a rule, when the government is no longer able to finance its deficit, it is forced to cut spending or raise revenues, often at times when fiscal policy is needed to help stabilize the economy.

The state borrowing is providing less room for the economic managers to ease the monetary stance to provide stimulus to the private sector of the country, which is facing stringent business environment amid several hurdles. The major victim of government's rising expenditure financing remains the private sector as crowding out effect is resisting them to grow as the financing options are not easily available for them. The commercial banks also prefer to shift their advances to cash strapped government to yield risk free return which is attractive amid high policy rate stance.

An understanding of the financing of fiscal deficit is also important because there are different implications of the method of debt financing in the economy. There are two sources of deficit financing: internal and external debt. Regarding domestic debt, the accumulation in domestic debt is from mainly three sources: (1) State Bank of Pakistan, (2) Commercial banks, and (3) Government securities/treasury bills to finance budget deficit. The government has become more dependent on banking sectors other than non-banking ones for domestic financing over the time.

It is an established fact that if debt financing is met by borrowing from Sate Bank, it has an inflationary affect; while if borrowing is from commercial banks then it crowds out of private sector investment. However, cost of debt is usually high, if it is met by issuing bonds. Apart from causing inflation, unrestricted access of the government to borrow from the State Bank complicates liquidity management, dilutes the impact of monetary policy stance and puts pressure on the exchange rate. There has been a significant increase in short-term debt, estimated at 55% of total debt. This has exposed the government to debt rollover and increase in interest rate.

Government expenditure is increasing gradually than revenue receipts in recent years partly due to adjustment to inflationary pressure and may keep on increasing further in the forthcoming years, creating more budgetary deficit. The largest sector of government expenditure, combining both development and non-development expenditure, is interest payment, which is also the single largest sector of non-development expenditure. Debt burden is increasing sharply over time due to increase in the budget deficit. The deficit of budget mainly occurs for the payment of interest, principal of debt burden and the subsidy which are mainly given to non-productive sectors.

Deficit financing, money supply and inflation are interlinked. Budget deficit and its financing in Pakistan, like in many other developing countries, is very important parameters for analyzing monetary and fiscal effects on the country's overall economic development. The government is indebted for debt servicing and deficit financing and the rate is rising swiftly.

Again, for external debt, foreign reserve is declining due to principal and interest payment. The dual effect is mainly responsible for devaluation of currency which in turn increases import bills and further induces debt to meet rising deficit. The government has to ensure adequate money supply which in turn increases further inflation. On the other hand, government debt from banking sector is hindering private investment. The outcome is lesser actual production than potential production and high inflation. Consequently, the average rate of inflation has increased. Trade balance is also facing adverse impact due to rising deficit, principal and interest payment, pressure on foreign reserve, rising import bills and devaluation of currency.

The sustainability of a government's debt position depends on certain variables such as interest rates, economic growth rates, government revenues and expenditure. Government debt has become unsustainable and it is continuously on rise indefinitely as a share of GDP. Sustainability is an issue of growing concern especially when the growth of government interest payments exceeds that of government revenues. Debt sustainability is an essential condition for macroeconomic stability and sustainable economic growth. But the fact of the matter is, debt condition of Pakistan is not sustainable because the country has more urgent needs than to make external debt service payments.

It is imperative that government now should look to improve tax collection and increase tax base to solve budget deficit problem. It is also critical for overall macroeconomic policy to manage the debt whereas it needs to be coordinated closely with fiscal, monetary and other macroeconomic and financial policies. Close coordination is needed to choose an appropriate mix of financing and policy adjustment to facilitate economic recovery while preventing the build-up of an unsustainable debt burden. Such economic condition hits the marginalized people of the country most. The practices of the government for adjusting excessive debt adversely affect the marginalized. The reduction in public investment due to servicing debt squeezes social security system. The eventual result is decrease in the real income of people that reduces purchasing power and increases level of poverty.