Debt & Econmy of Paistan
Debt & Econmy of Paistan
Debt & Econmy of Paistan
Introduction
Background
External debt plays both a positive and negative role in shaping economic
growth, particularly of the developing countries. External debt is helpful when the
government utilises it for investment-oriented projects such as power,
infrastructure and the agricultural sector. On the other hand, it would affect
negatively when it is used for private and public consumption purposes, which do
not bring any return. Additionally, a low level of external debt impacts economic
growth positively, but this relationship becomes negative at a higher level. The
specific turning points are 35-40% of the debt- gross domestic product (GDP)
ratio, and 160-170% of the export-debt ratio.1
Pakistans external debt is seen to be the cause of all ills afflicting the
economy. External debt increased from $19.200 billion in 1990 to $33.60 billion
in 1999 and further to $37.362 billion by 2007. Moreover, in most of the fiscal
years since independence, the governments revenue has less than its expenditure,
which in turn would cause fiscal deficit which could be bridged through
borrowing from both internal and external sources (debt). But the situation
becomes worse when the country is unable to repay its debt servicing.
Shahid Hasan Khan, Special Assistant on Economic Affairs to the Prime
Minister of Pakistan in the Benazir Bhuto government in 1993, said that the fiscal
deficit is the primary cause of all the ills of the economy. Consequently, any effort
aimed at rehabilitating the economy would have the elimination of fiscal deficit as
the number one item on the agenda.2 Every single IMF and World Bank
document on Pakistan also says that the external debt burden has been the primary
cause of all the ills of economy, especially since the start of the structural
adjustment programmes in 1988.3
External Debt and Economic Growth: Trends and Challenges A Case Study of Pakistan
(2000-2007)
Objective
This paper is an effort to study the impact of external debt in shaping the
economic growth in the case of Pakistan. It begins with the theory related to debt
and how it impinges on the economy. The paper traces out the root of Pakistans
external debt and evaluates how external debt was successfully managed by
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addressing the different policies and trends since 2000; and also addresses the
upcoming challenges for the new government.
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External Debt and Economic Growth: Trends and Challenges A Case Study of Pakistan
(2000-2007)
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sustainable levels. The major causative factors for this increase were the rising
level of current account deficit and a large fiscal deficit that raised the financing
needs of the country.
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External Debt and Economic Growth: Trends and Challenges A Case Study of Pakistan
(2000-2007)
EDL
2000
2001
2002
2003
2004
2005
2006
2007*
37.9
38.9
37.16
35.47
35.26
35.85
37.24
38.86
EDL/GDP
EDL/FEE
Percent
51.7
297.2
52.1
259.5
50.9
236.8
43.1
181.2
36.7
164.7
32.7
134.3
29.4
120.1
27.1
119.7
EDL/FER
Ratio
19.3
11.5
5.8
3.3
3
2.7
2.9
2.8
Despite the increase in total external debt and liability (EDL) from $37.9 in
2000 to $38.86 billion in 2007, the ratio of EDL to GDP retained a falling trend
since 2000 (see Figure-1). The fall in this ratio, due to high GDP growth, suggests
an improved potential of the economy to generate resources to service the fiscal
deficit.
The ratio of debt servicing to export earnings is also evidence of improvement
during 2007 as compared to 2006. As export earnings keep on growing but at a
slow rate, the debt servicing burden is not likely to cause deterioration in the ratio
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External Debt and Economic Growth: Trends and Challenges A Case Study of Pakistan
(2000-2007)
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The ratio of international reserves held by the country with the level
of reserves in the preceding year this ratio depicts changes in the
countrys international liquidity position. A higher value of this ratio
reflects rising stock of the countrys international reserves and thus its
higher ability to repay foreign liabilities.
The ratio of growth in exports to growth in countrys external debt
that gauges changes in countrys debt repayment capacity. A larger
value of this ratio and thus a faster growth in exports as compared to
external debt indicates a stronger debt repayment capacity.
The ratio of inflation in the previous period with the rate of inflation
in the current period a smaller number reflects erosion in the
countrys debt repayment capacity caused by higher inflation. Higher
inflation leads to a rise in the debt servicing cost of a country by
causing exchange rate depreciation.
The ratio of exports in the current period with exports in the preceding
period this ratio captures changes in a major source of a countrys
foreign exchange earnings that in turn impacts countrys debt
repayment capacity.
1.9
1.4
3.7
1.5
4.2
6.4
5.5
2.8
2.3
2.7
3.1
Exports/EDL
* growth
ratio
2.6
2.4
2.0
2.9
2.7
2.4
3.1
2.8
2.9
2.7
2.4
Inflation
ratio
Exports
ratio
Weighted
average
Political
stability
Index
1.4
2.3
2.0
2.3
1.3
1.9
1.7
1.0
0.7
1.8
1.5
1.6
1.4
1.4
1.7
1.6
1.5
1.8
1.7
1.8
1.7
1.6
7.5
7.5
9.1
8.4
9.8
12.2
12.1
8.2
7.7
9.0
8.6
1.0
1.0
1.0
2.5
2.0
1.0
2.0
2.0
2.0
1.5
1.0
8.5
8.5
10.1
10.9
11.8
13.2
14.1
10.2
9.7
10.5
9.6
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External Debt and Economic Growth: Trends and Challenges A Case Study of Pakistan
(2000-2007)
Weights assigned to the first two ratios are 2.5 each; while for the last two,
they are 1.5 each. The higher weights for the first two ratios suggest their
importance in impacting the countrys debt repayment capacity. The political
environment of also affects a countrys foreign exchange earning capacity that in
turn determines its debt repayment capacity.
Table-2.1: Interpretation of Results
Score
<6
6 -8
8 - 10
10
> 10
Interpretation
High likelihood of default
Serious oncoming problems.
Deterioration in debt servicing capacity
No significant change in debt servicing profile
Improvement in debt servicing profile
The external debt servicing vulnerability index is given in Table-2 and its
interpretation in Table-2.1. It is also important to note that the results of this
exercise will change significantly with the change of weights assigned to these
ratios. Here the weights assigned for the calculation of this index are taken from
Abdullah (1985) since the results that he obtained by using these weights passed
the test of reality for 20 major debtor countries in Latin America, Asia, Africa and
the Middle East.15
According to this index, Pakistan witnessed deterioration in its debt servicing
profile before 1999 (see Table-2). Conversely, the situation started to recover
mostly due to a significant rise in the stock of countrys international reserves (due
to remittances, foreign aid and privatisation) and growth in exports from 2000
onward, as shown in Table-2. The score on the vulnerability index after reaching
its highest value in 2003 began falling during 2004-2007 but remained in the
vicinity of 10, reflecting no significant change in the countrys debt repayment
profile.
The fall in the value of the index during 2004 to 2007 can be attributed to the
following factors:
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In addition, the loss in the value of the index in 2007 is due to rising political
uncertainty, as most ratios of macroeconomic performance of the country are
satisfactory to support the debt burden. Due to political instability and poor law
and order situation, foreign investment declined by about $2 billion, or 44 per
cent, from $4.62 billion, during eight months of the fiscal year 2007-08.16 Thus,
the index highlights the need for political stability in the country in order to avoid
any change in the perception of the creditors that can adversely affect the
countrys debt repayment capacity.
Challenges Ahead
As most of the highly indebted poor countries (HIPCs) are unable to sustain
their debt repayment capacity, they face the challenge of balancing the potential
risks of external borrowing against the benefits. Debt burden is an important factor
in assessing these risks, but it is not the only factor that can effect it, as much of
the upsurge in the debt burden in the HIPCs from the 1985 to 1995 was due to
their weak policy and institutional frameworks, low capacity for debt
management, lack of export diversification, and limited fiscal revenue capacity. 17
Thus, according to the above framework, Pakistan is still facing many
challenges. The current account deficit widened further in 2007-08, the tax-toGDP ratio is still very low, and inflation remained persistently high, showing only
a sluggish decline in 2007. The economy would continue to grow strongly during
the 2008 fiscal year, but external current account deficit and inflation would be the
key challenges to the economy.18
The following would be the main challenges for the new government:
Debt Servicing Liability
In the coming years, the country is likely to face a higher burden of debtservicing as repayments of the rescheduled non-ODA Paris club debt stock would
resume from the 2008 financial year. The maturities of the Eurobond issued in 2004
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External Debt and Economic Growth: Trends and Challenges A Case Study of Pakistan
(2000-2007)
financial year, and Sukuk issued in 2005 financial year would become due in the 2009
and 2010 financial year, respectively.19 Therefore, heavy debt service liabilities would
take a big chunk of national income. In addition, interest payments on various
Eurobonds, issued recently, are likely to add to debt-servicing burden in the coming
years.
Trade Imbalances
Pakistan'
s economy has amassed a huge trade deficit, with imports twice the
exports, which presents a great challenge to the country'
s economy for the upcoming
budget. Pakistan now faces an all-time high trade deficit. Adjusting the import and
export structures would remain the technique to balance international income and
expenses.
Inflation
According to Governor State Bank of Pakistan, key risks to the inflation outlook
appeared to be energy and food staple expenses in the wake of rising international
prices. Therefore, enhancing production in financial year 2008 would be critical for
easing production of the supply constraints, both to ease inflationary pressures and to
provide for export growth.20
Political Uncertainty
As already noted, political uncertainty has an impact on capital inflows which in
return may curtail investment, dragging down economic performance. That in turn
causes revenue shortfalls due to slow economic activity. Expenditure overruns may
also limit fiscal space and reduce public investment, which may affect private
investment and growth.
Foreign Direct Investment
Although the FDI increased during the last five years which is encouraging, it has
remained stuck to only three sectors (IT/telecom, banking and financial services and
energy) which yielded unexpectedly high returns to the investors. These same sectors
would remain attractive to foreign investors in future as well. Furthermore, political
instability and security concerns are the major reasons for the record decline in
portfolio inflows, as foreign investors are reluctant to invest in the equity market.
Tax Structure
The current fiscal deficit is due to the inability of the government to expand its
tax base, despite growth in incomes in terms of revenue collected. In addition, the
government has not been able to diversify the tax base. It is difficult to believe that
even now, highly profitable forms of earning wealth, such as agriculture and service
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sectors, and especially oil companies, banks and financial institutions, portfolio
investments, withdrawl of portfolio investments from Pakistan and real estate, are
exempt from substantive taxes.
Export Diversification
Pakistans exports continue to stagnate and have not diversified. Considering that,
any figure showing exports needs to be seen in the light of imports and a countrys
trade and balance of payments; on both counts, Pakistans statistics are far worse than
they have ever been.
Devaluation of Rupee
If the rupee is devalued or is floated down or if the dollar becomes stronger in the
international market, the rupee cost of the foreign debt goes up and the government
has to mobilise more rupees to repay the old loans. At the moment, the government is
buying dollars at almost Rs. 61 to service foreign loans obtained at Rs. 9.90 for a
dollar or a little more in the 1980s.
Conclusion
Pakistans external debt has shown a healthy improvement since 2000. The
total external debt liabilities which were equal to 51.7 per cent of its GDP in 2000
came down to 27.1 per cent of the GDP in 2007. This reduction has been backed
by debt management policies; in particular, the Debt Limitation Act, 2005; along
with a manifold increase in remittances, foreign aid, FDI and privatisation
revenues. Debt repayments had been the biggest constraint on the economy in the
previous decade of 1990s, and that was the main reason for the economy
performing poorly in the 1990s. The situation is, therefore, satisfactory to some
extent as compared to the 1990s on account of Pakistans repayment capacity.
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External Debt and Economic Growth: Trends and Challenges A Case Study of Pakistan
(2000-2007)
10
11
12
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13
14
15
16
17
18
19
20
21
A. R. Kemal, Macro Economic Management: Breaking Out of the Debt Trap, The
Lahore Journal of Economics, Special Edition 2005.
Abdullah A. Faud (1985), Development of an Advance Warning Indicator of
External Debt Servicing Vulnerability, Journal of International Business Studies,
Vol. 16, No. 3, p. 135-141; State Bank Pakistan, Annual Report 2007.
State Bank of Pakistan, Annual Report 2007.
Business Recorder report, March 20, 2008, at www.brecorder.com.pk
Sun, Yan, External Debt Sustainability in HIPC Completion Point Countries,
Working Paper 04/160, International Monetary Fund, Washington, DC, 2004.
State Bank of Pakistan report, Widening current account deficit, high inflation
serious challenges: SBP, Business Recorder report, October 30, 2007.
Fourth successive year of sustained high growth in economy: Governor SBP,
Shamshad Akhtars Address, Business Recorder report, October 30 2007, at
www.brecorder.com
Ibid
44 percent decline in foreign investment, Business Recorder report, March 20,
2008, at www.brecorder.com
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