1

What to do about Pakistan’s Mountain of Debt

Executive Summary

External debt and current account deficit are not just the biggest economic issues, they are a
national emergency. Solving them is critical for economic revival and security. If not done,
there is every chance that the economy may default or face a Sri Lanka type situation. The
Ukraine war with the ensuing supply problems and inflation, compound further an already
intractable situation.

But so far government’s only response is more loans from IMF, though it is known that the
problem does not arise merely from a lack of access to foreign assistance. While IMF is
needed, it is an insufficient response and one that ensures that before long we will have the
same problem again.

It is critical to know why such a crisis keeps happening every few years, exacting a huge cost
on the citizens. It also adds to the nation’s gloom and despondency. Even a casual analysis
convinces us that government must revisit its entire economic policy agenda. A plan to avoid
future current account crises should lie at the centre of any substantial engagement with the
IMF. To do so, we must set our own house in order and make some difficult and delicate
political choices. Consequently, this report

➢ Analyzes what causes the current account’s frequent breakdowns.

➢ Recommends near-term measures to manage the current account deficit
➢ Recommends medium term measures to put the current account on a sure footing to avoid
future such emergencies

It does not recommend populist measures being discussed in the policy space, such as
redistribution of land or cutting defence expenditure. Both would add to savings and
investments and boost economic activity, and we don’t disagree. But the report is conscious
of what is possible.

Why is an IMF agreement insufficient response? IMF’s mission is not growth and
development. It helps with temporary balance of payment emergency. IMF looks at debt
sustainability from a cash flow point of view. So, if Pakistan will receive enough loans to enable
it to meet this and coming years’ external payment obligations, including interest and
amortization (to service past loans), IMF considers the situation sustainable. This is a short-
term perspective emanating from the IMF’s mission to help member countries meet
emergency BoP challenges. As our over 20 visits to IMF testifies, Pakistan’s case is more
enduring in nature and entirely of its own making. The depth of reforms that our economy
needs can only be set right by strong and committed political leadership engaged with the
people of Pakistan and working for growth and development.

Behind the repeated crises are flawed policies. Resultantly, Pakistan has a constant trade
deficit, which we have not come to terms with and which results from inability to invest and
produce more. Figures 1 and 2 show that the economy’s debt level grows by a higher margin
in the years when the trade deficit is higher. When the economy grows by 2 to 3% Pakistan’s
export and remittances are enough to meet most imports. But when the economy grows by

2
about 5%, additional loans finance higher imports. That results in higher interest and
amortization payments and a current account crisis. The same happens when price of
essential imports such as energy and food suddenly increase.

The crisis results in a high cost to the economy from which it takes years to recover. It transfers
resources out of Pakistan. And the ensuing devaluation, tight monetary policy, and cuts in
public spending hurts the citizens and depresses economic activity. It is now a regular
occurrence.

The sum of the economy’s infrastructure, human resource, and institutional assets is good for
the economy to grow by up to 3%. Trouble arises when it wishes to grow at a higher rate. In
short, the economy has not accumulated enough capital for high growth. Clearly, a growth
rate of 2 to 3% is not an acceptable goal for the economy.

For twenty years, our savings and investment are in decline, Figure 3. Our exports are at a
perilous level of about 8% of GDP. They were at 19% in 1990. When savings fall, we invest
and produce less, leading to high imports financed with imported capital. Manufacturing
investment at about 1.5% of GDP is especially low, down from 4% of GDP in 2004. For the
last ten years, Pakistan has mostly focused on managing debt with more debt. This debt-on-
debt has led to our continuous impoverishment. Repayment and debt burden has depleted
capital within and our ability to grow by more than 2-3%.

Manufacturing needs infrastructure, quality people and solid legal and governance support.
Most rapidly growing economies set aside large sums of public money for the purpose
reinforced with high level monitoring.

Public spending has not increased the country’s productive capacity, see Figures 4 and 5.
PSDP has been in terminal decline. It has never been enough to meet our needs. Our flawed
political choice is evident from the trendlines. Fiscal deficit has been flat at about 6% of GDP,
while PSDP has fallen rapidly. So where is the money going?

It is going to payment of interest for foreign and domestic debt, which is about 40% of
government spending. And to subsidies led by IPPs and inefficient PSEs. When the
government asks us to give more tax, 40% of that increase will pay interest and 19% will pay
for subsidies and grants. (Though not all subsidy and grants are bad. The 19% does not
include BISP).

There are other issues that dampen export-oriented manufacturing. Access to credit and
especial incentives such as those offered for private power production, construction and duty
protection for auto assembly (for about 30 years). These incentives divert investment while
not contributing to exports directly. The power sector contributes to economic activity
generally,

The pressure of continuous borrowing for consumption and debt servicing without developing
the means to repay the loans makes the external account fragile. Tables 1 to 3 show rapid
growth in external debt. There is also a trend of worsening sustainability ratios as well as a
preference for shorter tenure and higher cost debt. Total foreign debt was less than $ 60 billion
in 2015. In six years, it more than doubled to over $ 130 B in December 2021, and the
borrowing continues, Table 3. But in those 6 years, exports of goods and services barely
increased from $ 30.5 billion to $ 31.5 B in FY 21. Foreign debt grew by over 200% in six

3
years, exports grew by 3%. During the same period, debt servicing, principal plus interest,
grew by about 250%. All sustainability indicators have worsened (Table 2).

Regarding debt tenor and cost, between 2010 and 2021 share of low cost mostly long-term
Paris Club debt have fallen from 25% to 8.8%. Share of multilateral loans has fallen from
42.7% to 27.6%. As against this, the share of high-cost bonds/sukuks went up from 2.7% to
6.4%, commercial loans from zero to 8.4% and other bilateral loans from 3% to 16%. Table 1.

What should Pakistan do?

Enough is enough we must get serious and everyone must play their part:

➢ Each year, GoP must set targets for fiscal and current account deficits and cut its coat
accordingly. Parliament must approve and monitor. The present ‘que sera, sera’ approach
must stop.
➢ Do not just rely on indirect taxes: GoP has limited the discussion about raising taxes to
indirect taxes such as higher petroleum levy, GST and import tariff. It serves the interest
of decision makers and lobbies. Figure 7 shows that despite lip service to increase of direct
taxes in every budget speech, and we will hear it again this year, its ratio is no better and
has gone down lately.
➢ Ask IMF for debt relief, see Box 2: Go beyond the programme to seek debt relief from all
lenders in the shape of reduction in interest rate, reduction in principal amount and
extending repayment period (the last could add to indebtedness). To convince them, we
must go with a sound plan for economic growth and correction of elite privilege. Pakistan
has credible cause to make the appeal, as explained in Box 2.
➢ If debt relief is not forthcoming, rescheduling is another option, but from all creditors and
no build-up of interest during rescheduled period.
➢ Increase exports: though production of exportable goods has not grown, make an item
wise study of what export could increase quickly, possibly with incentives.
➢ Imports: Do away with all non-essential goods imports. Also, make an item wise review to
find domestic substitutes for imports or bring some items quickly into production with
incentives.
➢ Earmark remittances for repayment of external debt by limiting imports.
➢ Prevent re-entry of Afghan transit imports to help rebuild our industry.
➢ In addition to a Saudi facility for deferred payment for oil, we may request the same of
Qatar.
➢ Restrict portfolio investment and end the volatility and transfer of resources that it causes
➢ Gradually we must start accessing external debt to only finance projects that create GDP
growth and exports. If over 70% of new debt is consumed as is happening now, the crisis
will never go away. This is a logic that even a village elder knows.

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Medium term recommendations

➢ Reduce budget deficit through debt relief, debt restructuring, and reforming subsidies. Use
the spared funds for development
➢ Make power sector financially sustainable to reduce burden on consumer and tax payers
and more predictable payments to producers.
➢ Restructure domestic debt.
➢ Recast the PSDP and reorient project selection metrics so that it supports exports by
raising private sector productivity
➢ Within SBP’s monetary supply limits keep liquidity flowing, through specific measures:
• Bring to fruition GoP’s old plans of setting up an EXIM bank. Use EMDF.
• SBP may ease regulatory requirements to increase credit for new manufacturing
investment
• Revive DFIs: Private sector needs fixed rate long-term financing for industrial growth

Increase productive capacity and self-reliance:

➢ Increase domestic sources of energy. Since 2012, government’s focus has been on import
of LNG. Need for a revised petroleum policy and especially a policy to begin shale gas
exploration by helping access to finance and technology and by risk sharing.
➢ Same for mineral resources.
➢ SBP’s recent effort for digitization of the economy will boost economic activity and
productivity. Need to strengthen this area.
➢ Transparency: Submit all international agreements of economic nature to parliamentary
review. If confidentiality is important, it may be a classified document with the relevant
parliamentary committee. Secrecy hasn’t worked. Examples are our high indebtedness
and international contracts that lead to arbitration awards against us. When something
goes wrong, as it frequently does, tax payers and consumers pay. Decision makers are
never held to account.
➢ Keep an eye on flight of capital. This is a challenging and nuanced issue, see Box 3.

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What to do about Pakistan’s mountain of debt

Reducing the economy’s external debt and current account deficit is not just the biggest
economic issue faced by the country. It is now a national emergency. Addressing it is critical
for economic revival as well as for economic security. If this is not done, there is every chance
that the economy may default or face a Sri Lanka type situation when it does not have the
means to import essential energy and food supplies.

Because the problem does not arise merely from a lack of access to foreign assistance, the
needed response must be broad based and cover a range of areas. GoP’s present focus is
on getting more credit to solve immediate challenges. While that is needed, it is an insufficient
response and one that ensures that before long we will have the same problem again. Our
over twenty visits to the IMF are testimony.

The present situation is dire and can no longer continue. To address the problem sufficiently,
it is critical to know why we keep coming to such a pass, so often. Even a casual analysis
convinces us that government must revisit its entire economic policy agenda. To do so, it must
make some difficult and delicate political choices. So far, there is no sign of that happening.

The external deficit is the outcome of many things that are wrong with our economic policy
formulation, some of which would take years to address. Thus, this paper is in three parts, as
follows:

➢ Part 1: Take stock of our current account weaknesses and what causes its frequent
breakdowns.
➢ Part 2: Recommend measures to manage the current account deficit in the near term.
➢ Part 3: Analyze issues for medium term measures to put the current account on a sure
footing to avoid future such emergencies and recommend measures for structural reforms

Even immediate measures would call upon the people of Pakistan to go through a period of
unpleasant adjustment. It would take political dexterity on the government’s part to assuage
them. But short-term fixing, which seems to be the government’s present approach, means
that the economy forever stays in a low growth-high debt trap, with a current account crisis
right around the corner.

The major point to consider is if there are any plans to put the current account on a sound
footing to avoid future crises. That should lie at the centre of a substantial engagement with
IMF. See Table 2, Sustainability Indicators. Each indicator in that Table has worsened in the
last ten years, during most of which years we have been in an IMF programme. The IMF looks
at debt sustainability from a cash flow point of view. So, if Pakistan will receive enough loans
to enable it to meet this and coming years’ interest and amortization obligations (to service
past loans), it considers the situation sustainable. This is a short-term perspective emanating
from the IMF’s mission to help member countries meet emergency BoP challenges. Pakistan’s
case is more enduring in nature, see Box 1 for the difference in approach between meeting
the short-term balance of payment challenge (the IMF approach) and what should be the
country’s long-term economic interest.

If government decides to take the more enduring route of reducing debt and moving to growth
and development, top-level leadership must lead the effort. No single ministry can manage

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the needed transition, especially not those ministries whose policies may have caused the
problem to begin with and who are swayed easily by IFIs views. As we will see below,
economic troubles arise from flawed political choices. Their solution cannot be outsourced to
a single ministry. Politics matters more. The depth of reforms that our economy needs can
only be set right by strong and committed political leadership engaged with the people of
Pakistan. The problem that we see today has occurred because of a continuous disconnect
between political and economic policy making. It is compounded by the influence of special
interests on economic decision makers. We may handle it with short term measures and stay
economically fragile, or take a long-term holistic approach.

A complex plan, such as the one needed now, calls for buy-in from all parts of the political
spectrum. On the surface it may seem that decision making in a broad-based coalition
government would pose a challenge. Yet representation in the Cabinet from all shades of
political opinions, could also be a source of strength. This is one more chance for political
leaders to rise to the challenge to take decisions in the long-term interest of the country, even
at temporary political cost to them.

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 Box 1: Difference between sustainability indicators

Exhibits 1 and 2 below are IMF’s estimate of Pakistan’s gross foreign financing needs and external account
sustainability for FYs 18 to 26. It estimates how much money Pakistan needs to stay afloat and how much of
that amount it can finance itself. This way it estimates how much funding Pakistan needs from IMF. First half
of Exhibit 1 is IMF’s estimate of gross financing needs. For FY 2022-23, IMF estimates it to be US $ 35,068
million. In the second half, IMF gives its estimate of the financing that Pakistan has arranged already US $
33,450 million. That part is titled ‘Available Financing”.
Of the $ 33,450 million ‘available financing’, estimated FDI is $ 3,063 million. The rest $ 30,259 million, or 91%
is debt from private and official creditors. IMF estimates balance need to be US $ 1,618 million, most of which
IMF would fund. The balance $ 533 million will be reserve depletion, Exhibit 1.
A few things are noteworthy. The major consideration for IMF in analyzing sustainability of Pakistan’s BoP is
the amount of external debt that Pakistan will receive. For FY 23, that amount is US $30,259. Even this debt
amount is an estimate that Pakistan may or may not receive. Usually, under an IMF programme, debtors are
forthcoming.
IMF bases our foreign financing needs on certain assumptions about the real and nominal GDP growth rates,
interest and inflation rates, Exhibit 2. What happens in actual fact has a bearing on the sustainability outcomes
even from IMF’s cash flow perspective. When growth outcomes are worse, Pakistan must go back to IMF.
For Pakistan’s economy, it is not enough to go with IMF’s definition of sustainability. This is because our
current account crisis is permanent. Pakistan must exercise a more robust watch on debt sustainability. Our
debt levels and annual servicing must support the goals of economic stability, growth and development. IMF’s
rationale is to offer temporary short-term balance of payments help to meet with a crisis. It assumes that the
recipient economy will undertake reforms to avoid such a crisis again.
But Pakistan has not made those fundamental reforms. Its especial crisis is of a permanent nature. That is
mainly because special interests within and outside the government. Special interests are doing very well.
The nation suffers.
The cash flow sustainability indicator also does not calculate the cost to the economy from outflows to creditors
and the resulting instability. A situation of debt funded cash flow is sustainable for a year or two, but ultimately
this new loan, the debt on debt, must be paid back. Pakistan must not look at the situation from the IMF’s
perspective of making sure the creditors get paid, but from what is good for the government’s finances. The
IMF deal is necessary without which we may default. Yet, how long we can pile debt on debt at a huge cost
to citizen welfare is for the government to look deeply at.
In an earlier paper, this Institute has shown the absurd folly of this approach. Since FY 2001, Pakistan has
paid an average of US $ 1.4 B annually in interest alone. Average interest paid in the last four years is US$
2.7B annually for a total of US $ 10.7 B since FY 18. Since FY 2001, Pakistan has paid external creditors
more than it has received from them. In 20 years, it has received $ 112.6 B and it has paid back $ 118 B in
interest and principal. Yet its external debt has grown by 228% from $ 37.2 B in FY 01 to $ 122.2 B in FY 21.
We may have paid back the original loan more than once and still owe it to the creditor. This is because often
the purpose of new loans is to repay past loans with the result that over 70% of new debt is to meet balance
of payments needs.
External debt must finance projects that create GDP growth and exports to enable the economy to repay. If
over 70% of new debt is consumed, the economy does not have the means to repay. This is a simple metrics
that most village elders understand well. Just the amount spent on interest on domestic and foreign debt (no
repayment) is 38% of federal government’s total expenditure. In the last three fiscal years, we have spent
between 78% and 103% of net federal revenue on just interest payments. Most other expenditure is met from
debt. We have piled debt on debt. This approach may serve elite interest, but the economy cannot go on like
this.

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 Cont’d Box 1:

Exhibit 1. Pakistan: Gross Financing Requirements and Sources, 2017/18–2025/26

(In millions of U.S. dollars, unless otherwise indicated)

2017/18 2018/19 2019/20 2020/21 2021/22 2022/23 2023/24 2024/25 2025/26

Est. Principle

Gross External Financing Requirements (A) 30,005 25,552 23,430 21,551 30,417 35,068 41,882 39,123 36,600
(In percent of GDP) 9.6 9.2 9.0 7.2 9.5 10.1 11.2 9.6 8.4
Current account deficit 19,195 13,434 4,449 1,916 12,994 12,163 12,363 12,230 11,789
(In percent of GDP) 6.1 4.9 1.7 0.6 4.1 3.5 3.3 3.0 2.7
Amortization 10,724 11,742 18,236 18,555 16,416 21,798 27,707 25,204 24,185
Public Sector 5,651 6,982 12,799 13,943 11,658 16,977 22,957 20,360 19,292
Short-term Borrowing 1,488 1,538 1,182 784 2,715 3,100 4,000 4,900 4,000
Long-term Borrowing (non-IMF) 4,163 4,444 10,617 13,159 7,942 12,877 17,957 15,460 13,492
Bonds 0 1,000 1,000 0 1,000 1,000 1,000 0 1,800
Private Sector 1/ 5,073 4,760 5,437 4,612 4,758 4,821 4,750 4,844 4,893
Short-term Borrowing 4,094 3,474 3,610 3,365 3,514 3,381 3,414 3,471 3,520
Long-term Borrowing 979 1,286 1,827 1,247 1,244 1,440 1,336 1,373 1,373
IMF Repurchases 86 376 745 1,080 1,007 1,107 1,812 1,689 626
Available Financing (B) 23,873 21,103 25,497 26,174 31,275 33,450 41,335 39,848 38,808
Foreign Direct Investment (net) 2/ 2,772 1,436 2,652 1,786 2,350 3,063 3,690 4,201 4,478
Disbursement 21,658 19,496 22,418 25,144 26,120 30,259 37,532 35,527 34,292
From private creditors 13,326 8,366 15,430 11,508 13,899 17,794 20,929 24,594 24,594
Disbursement to Private Sector 3/ 8,110 4,268 12,052 4,221 5,317 8,394 10,329 8,912 10,303
Disbursement to Public Sector 4/ 5,216 4,098 3,377 7,287 8,582 9,400 10,600 15,682 14,291
From official creditors (non-IMF) 8,332 11,130 6,989 13,636 12,222 12,465 16,603 10,934 9,697
o/w Project Loans 3,458 2,582 1,588 1,876 1,647 1,770 2,416 2,378 2,042
o/w China 1,811 1,574 487 204 63 100 127 127 0
o/w Program Loans 261 288 3,666 2,120 2,479 2,182 2,093 1,974 2,144
o/w WB 205 150 729 1,009 1,379 1,182 1,093 974 1,144
o/w ADB 50 87 2,347 858 738 1,000 1,000 1,000 1,000
o/w Rollover of short-term debt 5,344 8,244 12,631 8,945 10,567 10,014 10,043 10,395 9,703
o/w Public Sector 1,871 6,193 4,627 5,245 7,100 7,100 7,100 7,100 7,100
o/w Private Sector 3,474 2,051 8,004 3,700 3,467 2,914 2,943 3,295 2,603
Other Net Capital Inflows (net) 5/ -557 171 427 -756 38 127 113 120 39
IMF SDR allocation 0 0 0 0 2,767 0 0 0 0

Remaining Financing Needs (C=A-B) 6,132 4,449 -2,067 -4,623 -858 1,618 546 -725 -2,208
Borrowing from IMF (D) 0 0 2,834 499 3,056 1,085 0 0 0
Reserve Assets (decrease = +) (E=C-D) 6,132 4,449 -4,901 -5,122 -3,914 533 546 -725 -2,208
Memorandum items:
Gross official reserves (stock, in US$ billions) 9.8 7.3 12.2 17.3 21.2 20.7 20.1 20.9 23.1
(In months of prospective imports) 1.9 1.7 2.4 2.7 3.2 3.0 2.8 2.8 2.8
(In percent of IMF ARA metric: assuming fixed 37.1 32.3 35.4 46.4 52.1 47.1 42.9 42.0 46.0
ER)
(In percent of IMF ARA metric: assuming 48.3 35.0 55.2 73.8 81.2 72.3 65.9 64.4 72.0
flexible ER)
Net FX derivative position (in US$ billions) 6.7 8.1 5.8 4.9 4.0 4.0 4.0 4.0 4.0

Sources: State Bank of Pakistan, and Fund staff estimates and projections.
1/ Includes banks and non-bank private sector.
2/ Includes privatization receipts.
3/ Includes equity and debt portfolio inflows, and borrowing by banks and other sectors.
4/ Includes syndicated loans and Euro bonds.
5/ Includes capital account, financial derivatives, errors and omissions.

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 Cont’d Box 1:

Exhibit 2. Pakistan: External Debt Sustainability Framework, 2016–26

(Percent of GDP, unless otherwise indicated)

Actual Projections

2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 Debt-
stabilizing
non-interest
current
account 6/
Baseline: External debt 26.1 27.0 30.0 37.4 41.6 39.1 40.6 40.1 39.1 37.7 35.2 -2.4

Change in external debt 2.4 0.9 3.0 7.4 4.2 -2.5 1.5 -0.5 -1.0 -1.4 -2.5
Identified external debt-creating 0.3 1.0 4.5 8.2 2.9 -1.4 1.9 0.9 0.5 0.2 -0.1
flows (4+8+9)
Current account deficit, 1.0 3.2 5.2 3.5 0.3 -0.3 2.9 2.3 2.1 1.8 1.5
excluding interest payments
Deficit in balance of goods and 8.2 10.1 11.9 11.8 9.3 10.1 12.6 11.5 11.1 10.4 9.9
services
Exports 9.9 9.2 9.8 10.9 10.7 10.5 11.4 11.1 11.0 10.9 10.8
Imports 18.0 19.2 21.7 22.7 20.0 20.6 24.0 22.7 22.1 21.3 20.7
Net non-debt creating capital -0.9 -0.8 -0.9 -0.5 -1.0 -0.6 -0.7 -0.9 -1.0 -1.0 -1.0
inflows (negative)
Automatic debt dynamics 1/ 0.1 -1.5 0.2 5.2 3.6 -0.5 -0.3 -0.5 -0.6 -0.6 -0.5
Contribution from nominal 0.8 0.8 1.0 1.3 1.4 0.9 1.2 1.2 1.2 1.2 1.2
interest rate
Contribution from real GDP -1.1 -1.2 -1.5 -0.7 0.2 -1.4 -1.4 -1.7 -1.9 -1.8 -1.8
growth
Contribution from price and 0.4 -1.0 0.7 4.6 2.0 ... ... ... .. . ... ...
exchange rate changes 2/
Residual, incl. change in gross 2.1 -0.1 -1.5 -0.9 1.3 -1.1 -0.4 -1.5 -1.4 -1.6 -2.4
foreign assets (2-3) 3/
External debt-to-exports ratio (in 265.0 294.7 306.9 342.6 388.8 370.8 355.7 360.4 354.7 345.3 324.9
percent)
Gross external financing need 11.6 22.0 28.5 26.6 19.8 21.6 30.4 35.1 41.9 39.1 36.6
(in billions of US dollars) 4/
in percent of GDP 4.2 7.2 9.1 9.6 7.6 7.2 9.5 10.1 11.2 9.6 8.4
10-Year 10-Year
Scenario with key variables at 39.1 40.2 40.5 40.5 40.6 39.2 -1.1
their historical averages 5/
Key Macroeconomic
Historical Standard
Assumptions Underlying
Average Deviation
Baseline

Real GDP growth (in percent) 4.6 5.2 5.5 2.1 -0.5 3.6 1.7 3.9 4.0 4.5 5.0 5.0 5.0
GDP deflator in US dollars -1.6 4.1 -2.6 -13.3 -5.1 0.7 7.8 9.9 2.7 3.7 2.7 3.6 2.6
(change in percent)
Nominal external interest rate (in 3.4 3.3 3.7 3.9 3.7 3.0 0.6 2.5 3.1 3.3 3.3 3.4 3.5
percent)
Growth of exports (US dollar -8.5 1.8 9.7 -1.3 -7.4 1.6 10.0 12.7 15.6 5.5 6.9 7.7 6.9
terms, in percent)
Growth of imports (US dollar -0.2 16.9 16.0 -7.6 -16.6 3.8 11.0 17.7 24.4 2.2 5.1 4.8 5.0
terms, in percent)
Current account balance, excluding -1.0 -3.2 -5.2 -3.5 -0.3 -1.5 1.8 0.3 -2.9 -2.3 -2.1 -1.8 -1.5
interest payments
Net non-debt creating capital 0.9 0.8 0.9 0.5 1.0 0.7 0.2 0.6 0.7 0.9 1.0 1.0 1.0
inflows

1/ Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic
GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency
denominated debt in total external debt.
2/ The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating
domestic currency (e > 0) and rising inflation (based on GDP deflator).
3/ For projection, line includes the impact of price and exchange rate changes.
4/ Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.
5/ The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of
GDP.
6/ Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt
inflows in percent of GDP) remain at their levels of the last projection year.

End of Box 1

10
Part 1: Take stock of our current account weaknesses and what causes its frequent
breakdowns.

Taking stock and what is wrong

➢ A look at the external account reveals a few characteristics:

• A huge trade deficit is behind our current account troubles. In Figure 1, notice the
divergence between trade deficit (the gray line) and yearly change in external debt
levels (blue line)1. Higher trade deficit brings higher increase in debt. The first obvious
lesson to draw is that the economy must focus on export growth, as this Institute has
emphasised many times before. Both macroeconomic stability and economic growth
would follow.

Figure 1: Relationship between trade deficit and debt levels,

FY 10 - FY 21

20000

10000

-10000

-20000

-30000

-40000

Ext debt change Ext debt servicing P + I Balance on trade in goods and services

• Yet when we add remittances to it the current account deficit is not that high. In
Figure 2, for the first few years the blue line is close to zero. That is, except when
Pakistan wants to grow rapidly. Imports shoot up and the current account deficit
becomes unsustainable. The current account is manageable when the economy
grows at about 3%. It gets out of hand at a growth rate of 5% or so, especially with
increased import of machinery to build production capacity. It is also
unmanageable when energy costs suddenly rise, as is happening now. In Figure
2, the two worst years are 2018-19, when CPEC imports were high.

1 Additional debt incurred each year

11
 Figure 2: Current account balance as % of GDP
2010-21

-1

-2

-3

-4

-5

-6

-7

• We finance the sudden rise in imports with high-cost debt. That causes the red line in
Figure 1 to rise as loan amortization and interest payments increase quickly, red line.
With imports in most years roughly equal to exports plus remittances, the economy
does not have the capacity for high growth nor the resilience to withstand sudden
external emergencies caused say by a hike in energy prices.
• The cost to the economy of this weakness is very high. It leads to transfer of resources
out of Pakistan while getting nothing in return. And the ensuing devaluation, tight
monetary policy, and cuts in public spending exact a high cost on the citizens and
cause further loss in economic activity. This is now a regular occurrence and one that
results entirely from political choice.
➢ Should we then stick to a growth rate of two or three percent annually? As that is close to
the natural increase in population, it means just marginal improvement in living standards.
However, that is better than the volatile periods of high-cost current account deficit when
the nation goes through a demoralising turmoil.
➢ We need deeper consideration before being swayed by our belief in the ability for rapid
economic growth.
➢ IPR research suggests that the present structure of our economy cannot support a growth
rate higher than 2 to 3%. That means that the sum of our infrastructure, human resource,
and institutional assets is good for the economy to grow by up to 3%. In short, the economy
has not accumulated enough capital for high growth. Clearly, a growth rate of 2 to 3% is
not an acceptable goal for the economy. Before we move forward about what to do, there
are a few more trends to take note of below:

12
 • Falling savings, investment, and exports, Figure 3. For twenty years, our savings and
investment have declined, see the blue and olive lines. Along with them, our exports
have taken a perilous hit, violet line. Export was 8.5% of GDP in FY 21. In 1991, exports
were 17% of GDP. The red line in the chart tells us why. Exports have fallen because
manufacturing investment has been especially low and in decline. It is barely one and
a half percent of GDP. There aren’t enough incentives for manufacturing to grow.

Figure 3: Trends in Savings, Investment, Manufacturing

investment, and Exports
% of GDP

25

20

15

10

0
2003-04 2007-08 2012-13 2017-18 2018-19 2020-21

Investment Manufacturing Savings Exports

Source: Pakistan Economic Survey, relevant years

➢ Let’s step back and see what is happening. We started with the economy’s essential
vulnerability, the current account deficit. We find that the current account is sustainable at
a GDP growth rate of 2 to 3%, but not if we want to grow at a higher rate. That is exports
helped by remittances are enough to pay for just that much import. If we grow, at a higher
rate, imports grow for which we must borrow. The last chart above shows that for decades
our savings and investment rates have fallen and with them exports. When savings fall,
we invest and produce less, leading to high imports financed from imported capital.
➢ Also important is the gap between manufacturing investment and total investment. Prima
facie, it is because of incentives and supporting activity. So, this chart takes us into the
more important area of the links between what is happening in the domestic economy and
their effect on exports and the current account. Exports will not rise just by wishing so.
There are processes behind what causes manufacturing and exports to grow. We now
review the processes that support manufacturing and exports. That takes us to
government’s fiscal operations and the budget deficit and its approach to policy:

13
• All business activity, especially manufacturing, need infrastructure, quality people and
solid legal and governance support. Governments must supply power and other
utilities as well as predictable and stress-free enforcement of laws. Most rapidly
growing economies set aside considerable sums of public money to this end. This
doesn’t happen in Pakistan.
• Public spending has not helped increase the country’s productive capacity, see
Figures 4 and 5. Government builds infrastructure and human resource through
allocations in the PSDP. But PSDP has been in terminal decline. It has never been
enough to meet our needs.
The economy is under investing in key infrastructure areas that cause growth.
Expenditure as % of GDP on health education has been flat throughout the years of
high fiscal deficit. Our flawed political choice is evident from the trendlines added to
the chart below. Fiscal deficit has been flat at about 6% of GDP, while PSDP has fallen
rapidly.

Figure 4: Relationship between Fiscal Deficit and PSDP

as % of GDP
10

0
1991 93 95 97 99 2004 2006 2008 2012 2015 2017 2020

Fiscal deficit PSDP Linear (Fiscal deficit) Linear (PSDP )

Source: Pakistan Economic Survey

14
 Figure 5: Expenditure as % of GDP
on Education (brown line) and Health (gray line), 1970-2016

Source: Pakistan Journal of Humanities and Social Sciences, October – December

2018, Public Investment in Social Sector in Pakistan: Trends and Issues, Sadia
Idrees, and Nor’Aznin, Abu Bakar

Yet, despite low public spending on such essentials, government’s budget

deficit is high.

If public investment is down, where is government money going? To subsidies

led by IPPs and inefficient PSEs. But mostly to paying of interest to domestic
and foreign creditors. When the government says that it will increase tax to
GDP ratio, 40% of that increase will pay interest and 19% will pay for subsidies
and grants. Not all subsidy and grants are inefficient spending. Some grants
help the vulnerable population (BISP is not included here). Others help in
supporting economic activity.

Largely, government does not spend the money judiciously and nowhere
enough that would help build a solid manufacturing base in the country to boost
exports. Its priorities are misplaced.

15
 Figure 6: How government spends our tax money

6
7

9 38

18

19

Interest Subsidies and Grant Defence PSDP Civil government Pension

➢ Let’s go back to Figure 3, ‘Trends in Savings, Investment, Manufacturing, and Exports, %

of GDP’. We may spend a minute on what explains for the large difference between total
investment and manufacturing investment. Total investment to GDP of about 15% goes to
a lot of economic sectors. Agriculture usually has the biggest share, followed by housing
and then manufacturing. Where the investment goes is a business decision, depending on
demand for output and on the available technical and financial resources. In addition to a
lack of infrastructure and human resource, investment in ‘manufacturing for export’ suffers
from inadequate incentives. Especial incentives or duty protection available for preferred
sectors, such as private power production, construction and auto assembly diverts a lot of
investment towards these areas. These three areas increase imports, but do not contribute
to exports directly. The power sector contributes to economic activity generally, including
exports. To revive manufacturing and exports, government must offer credit and financial
incentives to selected export industries. It offers incentives to some non-export
manufacturing such as duty advantage for motor car assembly. (The auto industry
produces products at a cost and quality that do not enable it to compete in the export
market. There are suspicions of transfer pricing to avoid taxes3, while customers suffer
from late delivery and indifferent service).

2MoF, Fiscal Operations FY 21, data

3 A number of publications give a good account of such informal flows by MNCs globally: 1. UN
University WIDER, Working Paper Are less developed countries more exposed to multinational tax
avoidance? Niels Johannesen, Thomas Tørsløv, Ludvig Wier, 2017, 2. OECD, Measuring and
Monitoring BEPS, Action 11 - 2015 Final Report, 3. Transfer Pricing and Tax Havens: Mending the LDC
Revenue Net, Charles E. McLure, Jr. Hoover Institute, Stanford University, International Studies
Program Public Finance Conference, The Challenges of Tax Reform in a Global Economy,
https://www.issuelab.org/resources/5323/5323.pdf

16
➢ To sum up, export-oriented manufacturing investment suffers from a combination of
insufficient public goods, weak governance, difficulties in access to credit, and lack of a
host of other incentives that government makes available to other businesses that do not
produce tradeable goods.
What we have seen here briefly are the many processes whose poor functioning causes
the current account deficit and stagnant exports. They form the links between the external
account and the rest of the economy. Fixing the current account is not just a matter of
accessing more debt to fund the deficit as the Finance Ministry has done for decades, and
is doing now. While that helps with the immediate emergency, it also makes the problem
worse. Solid work to rebuild manufacturing is needed to put the current account on sound
footing. Doing so is critical for economic development. There is not even a discussion on
this issue.
Below is a summary of the structural issues in the Pakistan economy that cause a
continuous current account balance:

Structural Issues that lead to persistent current account deficit

Low
investment

Low R&D
and Low
innovation productivity

Inflation

17
Some Risks

➢ The risks of not changing our priorities are very high. During 2003 to 2007 and in 2015-
2018, Pakistan celebrated moderate to high GDP growth. But those were economic growth
without exports or even jobs. As expected, the economy suffered soon after these booms
with severe loss in welfare from devaluation, fall in GDP growth and massive borrowing.
This led to a fall in per capita income. It is a perilous path to take. We have the example
of Sri Lanka. Sri Lanka has been unable to pay for import of key goods for want of foreign
exchange. Consequently, it suffers long hours of power cuts because the economy is
unable to import fuel. Even medicines are in short supply. If this happens, we cannot rule
out social unrest, especially in the context of current political uncertainty.
The resultant debt problem
The pressure of continuous borrowing for consumption and debt servicing has increased
the fragility of the external account. Tables 1 to 3 below show that not only has our external
debt grown rapidly. There is also a trend of worsening sustainability ratios as well as a
preference for shorter tenure and higher cost debt.
Total foreign debt was less than $ 60 billion in 2015. In six years, it has more than doubled
to over $ 130 B in December 2021, and the borrowing continues, Table 3.
On the other hand, in FY 2015, exports of goods and services was $ 30.4. It barely
increased to $ 31.5 B in FY 21. So, while foreign debt grew by over 200% in six years,
exports grew by a small 3%. During the same period, debt servicing grew by about 250%.
When remittances are added to exports, foreign exchange earnings grew by 24% between
FY 15 and 21, nowhere close to the growth of 250% in debt servicing. It seems that
governments in Pakistan have kept borrowing without any thought about how they will
repay.
Similarly, debt profile has changed, Table 1. Average debt tenor has reduced and cost of
borrowing have increased. Thus, we see that between 2010 and 2021 share of low cost
mostly long-term Paris Club debt have gone down from 25% to 8.8%. Share of multilateral
debt, another source of concessional loans, fell from 42.7% to 27.6%. As against this, the
share of high-cost bonds/sukuks went up from 2.7% to 6.4%. Cost of the three bonds
floated in FY 21 ranged between 6% and 8.9%. Share of commercial loans are up from
zero in 2010 to 8.4% of total debt in 2021. Their cost is in the range of 5%. Share of ‘Other
bilateral’ loans, mostly from China has grown from 3% to over 16%. Their cost is higher
than Paris Club debt. So, from a share of 68% of total debt, loans from IFIs and Paris Club
now have a share of 36.4%. While the total of bonds, commercial loans, and other bilateral
loans have grown from 6% of total to 31%. Not only has debt grown, but the share of high-
cost debt is now virtually at par with concessional credit. Government’s frequent resort to
market-based financing is especially a source of concern. No surprise that all sustainability
indicators are worse than before, Table 2.

18
 Table 1: Share by lending source 4
%

2010 2015 2021

Paris Club 25.1 17.9 8.8

Multilateral 42.7 37.3 27.6
Other bilateral 3.3 7.5 16
Bonds Euro/Sukuk 2.7 6.9 6.4
Commercial loans incl PSEs 0 0.4 8.4
Government FOREX Liabilities 2 5.7 7.2

Table 2: Debt Sustainability Indicators 5

In percent

FY 2010 FY 2015 FY 2021

Total Ext Debt/GDP 31.8 24.2 40.66

Total Ext debt/Exports 183 117.1 384

Total Ext debt service P+I/GDP 3.2 2.0 3.8
Reserves/Short term debt 1800 385 304
Debt Servicing/Total revenue (fed + prov),
interest on public debt, domestic and 30.9 33.2 39.8
foreign
External debt servicing (P+I)/Exports 28.9 22.5 52.3

External debt servicing (P+I)/Exports +

16.7 18.4 22.0
Remittances

4 SBP data
5 SBP debt, forex, and balance of payments data
6 IMF calculation Table 1. Pakistan: External Debt Sustainability Framework, 2016–26

19
 Table 3: Pakistan External Debt and Liabilities
Billion USD

June June June June June June

2007 2013 2018 2019 2020 2021

Public Debt (PSEs included) 38.1 52.6 78.1 88.1 92.9 102.2

Public and Guaranteed Debt 38.1 50.2 75.4 83.9 87.9 95.2
• Multilateral and Paris Club 31.4 37.7 39.7 39.0 41.8 44.6
• Other bilateral 1.0 2.9 8.7 12.7 13.4 14.8
• Bonds, Sukuks, commercial 2.9 1.6 14.1 14.8 13.6 17.5
• Short-term debt 0 0 1.6 1.3 1.5 0.9
• IMF 1.4 1.4 6.1 5.6 7.7 7.4
• Forex Liabilities guaranteed 1.4 2.4 5.1 10.5 9.9 8.8
• PSEs -- 2.1 2.7 3.9 4.9 6.7
Banks -- 1.5 4.4 4.7 4.5 5.3
Private debt, non-guaranteed 2.0 3.1 9.2 10.5 11.1 10.9
Intercompany debt -- 2.8 3.6 3.3 4.4 4.1
Total Ext Debt & Liabilities 40.1 59.8 95.2 106.3 112.9 122.2
Official liquid reserves 13.3 6.0 9.9 7.7 12.5 17.4
Ext Debt & Liabilities % of GDP 28 25 30 37 457 35
GDP in Billion USD 144 237 313 279 264 3478

Source: SBP Annual State of the Economy Report

Looking at risks, another major development is the Ukraine war. We have seen its effect
on energy prices. The war also has led to global inflation. In addition to energy, food prices
are up while there is global slowdown in growth. Economies such as Pakistan that are net
importers of food and fuel and dependent on foreign capital have been hit hard. Our policy
framework, which does not focus on industrial development but mostly on managing public
finance and the external account renders the economy unable to withstand such crises.
The possible help from Saudi Arabia for deferred payment for oil import would help. All
those measures that can possibly insulate us from the harmful effect of Ukraine is
necessary to consider. Whether getting by with the goodwill of others is acceptable policy
for a nuclear weapons country is for the leadership to decide.

IPR’s report “Foreign Aid and its Purpose” of April 2021 describes the folly of the policies
we have pursued.

7 Source for EDL/GDP is SBP’s Annual State of the Economy Report FY 20, Pg 81, Table 5.7
8 Rebased and revised GDP by government

20
Part 2: Recommend measures to manage the current account deficit in the near term.

What should Pakistan do?

For this and coming four years, IMF’s projected gross financing needs is between $ 30 and
40 billion9. With this year’s current account deficit expected to reach $ 17.5 billion, our dollar
gross financing need is about $ 35 billion. Reportedly, GoP needs another $ 9 to 12 billion in
addition to what it has10. And there is not much time:

➢ GoP must set targets for fiscal and current account deficits. Parliament must approve. It
must therefore customize its spending accordingly.
➢ While there is an in-principle agreement with the IMF, government must take politically
unpopular decisions to conclude the arrangement. Yet, it must be done to stabilize the
economy. In any case, the price freeze in February 2022 was for political reasons and had
no economic logic.
➢ For decades, decision makers have framed the discussion about increasing tax to GDP
ratio by referring only to indirect taxes and levy. So, higher petroleum levy, GST and import
tariff find mention while discussing budget deficit. It entirely serves interest of decision
makers and influential lobbies. In Figure 7 below, the blue line represents direct taxes.
Despite lip service to its increase in every budget speech, and we will hear it again this
year, the ratio of direct taxes to GDP has not improved. In fact, it has fallen in the last three
years. Contribution of indirect taxes, red line, is about twice as much. The gray line
measures the share of direct taxes to total tax collection, on the right vertical axis, Its share
has fluctuated between 32.5% in FY 20 to 35% in FY 14. Repeated tax exemptions and
favourable tax rates prevents increase in the share of direct taxes. The common person is
expected to keep funding the large budget deficit which entirely arises from poor policies
that serve elite interests (those of creditors, IPPs and other PSEs, untaxed agriculturists,
and lower PSDP for all). This coupled with high inflation caused mostly by increase in
administered prices is a huge burden on the common people.

9 IMF, 2021 Article IV Consultation, Sixth Review Under the Extended Arrangement Under the Extended
Fund Facility, Table 3b. Pakistan: Gross Financing Requirements and Sources, 2017/18–2025/26, page
41
10 Dawn, Experts call for comprehensive economic reform strategy, Jamal Shahid, April 24, 2022

21
 Figure 7: Low Direct Taxes
FYs 13 to 21
9% 36%

8% 35%

7% 35%

6% 34%

5% 34%

4% 33%

3% 33%

2% 32%

1% 32%

0% 31%
Direct tax/GDP Indirect tax/GDP Direct tax/Total Tax Linear (Direct tax/Total Tax)

➢ Debt relief: Go beyond the programme to seek debt relief. Debt relief includes either
reduction in interest rate on debt or a reduction in principle amount of the debt. It also
means extending the repayment period. Or it could be a combination of the three.
Pakistan has a credible basis to make the appeal, see Box 2. Still, it would need very able
persuasion by Pakistan in world capitals for advocacy with the IMF. It has to be done if we
are to avoid a Sri Lanka like situation.
Debt relief is in the interest of Pakistan as well as the creditors. If we look at the debt
structure and profile and the pace at which our external debt has grown, a substantial
repayment in the coming years is not possible. Relief to bring down our obligations, so that
they are in line with the economy’s capacity to repay and service, is in the interest of both
Pakistan and the creditors.
In the last 20 years, Pakistan has paid 2% to 8% of GDP in debt servicing (principal plus
interest), the red line on the right axis. Total amount that outflowed each year has ranged

Figure 8: Debt Servicing P+I

16 9%

14 8%

12 7%
6%
10
5%
8
4%
6
3%
4 2%
2 1%
0 0%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Debt Serv P+I, $B Debt servicing/GDP

22
 between US $ 3 billion and 14 billion annually. These are very large sums of money leaving
the economy. The benefit to the economy is unclear.
IFIs agree to debt relief when an economy’s debt structure is not sustainable. But as
pointed out, IMF considers our debt sustainable by financing it with more debt. From the
country’s point of view that is a sub-optimal position and inherently not sustainable, other
than for a short time. Thus, our repeated visits to IMF.
Because definitions of sustainability vary, we must persuade IMF via other major world
capitals. The present IMF leadership has a holistic approach to debt and could be
amenable if approached with a credible plan for avoiding to seek future concessions. ‘A
2002 IMF report concurs: “restructuring can increase returns to all parties in cases where
debt is unsustainable.”11’
However, Pakistan has availed Paris Club rescheduling before. To convince them that we
are serious about not knocking on their door again, we must share a robust growth plan
that would put Pakistan on a sustainable path in terms of the balance of payment12. The
economic growth plan must include measures to build private productivity and exports.
Our record is not impeccable. Pakistan has been less than judicious in using foreign loans.
Lenders too though have funded low impact projects and programmes, whose ideas often
originated with the IFIs13. This is clear from their own evaluation reports.
IMF levies a surcharge on the loans. While it sounds innocuous, it adds to the debt
burden in a major way, According to Fortune magazine, “added burden from surcharges
is no trivial amount … 16 countries are paying IMF surcharges, which increase their
collective borrowing costs by over 64%.”. The Center for Economic and Policy Research
(CEPR)14 estimates that surcharges make up close to half of all non-principal debt service
owed to the Fund by its five largest borrowers15. Pakistan must make this request to the
IMF and other IFIs and bilateral creditors.
➢ If debt relief is not forthcoming, rescheduling is another option. Two things are important.
All creditors, not just Paris Club, must reschedule and they must not charge interest during
the rescheduled period. Otherwise, rescheduling increases indebtedness. Nothing will be
easy, but we must try to gain lenders’ confidence and to make the exercise meaningful for
us. Of late, China has become a major lender. Debt relief or rescheduling is not possible
or meaningful without Chinese loans being part of the rescheduling exercise. Money is
fungible and Western economies are deeply averse to using the money made available
from rescheduling of their loans to service Chinese loans. Also, Paris Club loans are more
concessional than non-Paris Club loans. A couple of examples below:

11 Business Recorder, How to solve the debt crisis, Arshad Zaman 22 Apr, 2022. The writer gives a six-
step how-to on domestic debt restructuring, italics added
12 Project Syndicate, Desperately Seeking a Mechanism for Sovereign Debt Restructuring, Anne O.

Krueger, 22 April 2022

13 The News, The economy needs rapid improvement, Humayun Akhtar Khan, 14 April 2022,

https://www.thenews.com.pk/print/950021-the-economy-needs-rapid-improvement
14 Centre for Economic Policy Research (CEPR), based in London, is a distributed network of

economists, who are affiliated with but not employed by CEPR, and who collaborate through the Centre
on a wide range of policy-related research projects and dissemination activities.
15 Fortune Commentary, Now would be a good time for the IMF to do away with unfair and unnecessary

surcharges, Shereen Talaat and Dan Beeton, April 22, 2022

23
 Table 4: Comparison of terms of debt from sources

Amortization
Lender Amount Rate
Years

Fixed 0.1 & LIBOR Yen 06

FY 2016-17 Japan USD 23.8 M 30
Months + 0.1, = 0.44%

Fixed 2 & LIBOR 06 Months +

FY 2016-17 China 729.4 M 20
2.8, = 6.78%
IDB, Short- LIBOR 12 Months + 2.22, =
FY 2016-17 700.0 M 1
term 4.72%

World Bank
FY 2016-17 761.2 M 25 Between 1.88 and 3.2 Fixed
IDA

Source: Pakistan Economic Survey FY 20, Table 9.5 of Statistical Supplement Japan and WB are
concessional sources. IDB Islamic Development Bank, IDA is WB’s concessional window.

As we borrow more with the soon to be renewed IMF arrangement, we must also find other
ways to reduce the debt and debt servicing burden:
➢ Increase exports: given that the country’s production base, especially of tradeable goods,
has not grown much, there are few commodities available to rapidly increase exports by a
large margin. Yet, GoP may make an item wise review of goods whose exports can
increase quickly. GOP should incentivize manufacturers of such items. This would need
special effort and may lead to a marginal increase. But even a $ 1 Billion annual increase
is important in the current state the economy is in.
➢ Imports: Effort to limit imports may take two forms. Immediately, do away with non-
essential goods imports. As luxury imports into Pakistan are limited already, this effort may
include those goods whose substitutes are reasonably available in Pakistan. Here too GoP
must make a line-by-line review.
This may include also those imported goods whose substitutes can be easily brought back
into production domestically. Food items come to mind, especially those in which the
economy was surplus until recently. Two examples are wheat and raw cotton, which
Pakistan now imports. Experts in government and academia may study what combination
of policies would quickly increase production, such as change in support price, especial
measures to improve and subsidize input supply such as fertilizer, pesticide, prioritized
water, storage of produce, or prioritized farm credit for specific products.
➢ Government must make especial efforts to prevent re-entry of Afghan transit imports.
These re-imports have done great damage to our manufacturing sector.
➢ Earmark remittances to pay back loan, rather than just borrow to repay. Of course, money
is fungible, but earmarking sets a clear target in the government’s mind to direct a certain
amount towards debt repayment. Even 10% would mean a reduction in debt by $ 3 billion.
Less foreign exchange available for import, would force government to curtail imports and
find substitutes in Pakistan.

24
➢ In addition to a Saudi facility for deferred payment for oil, we may request the same of
Qatar, if the government has revived the long-term LNG contract. Energy exporters are
windfall beneficiaries of recent hike in prices. Government may request Qatar for partial
interest free deferment of payments, or if possible, payment in Rupees.
➢ All this calls for especial efforts by appealing to the global leadership. This especial effort
must be based on our diplomatic as well as strategic relations.
➢ Restrict portfolio investment into the country. Contrary to the widely held belief that
portfolio investment lends forex exchange buffer, their unrestricted two-way flow is a
source of volatility and uncertainty. They are speculative in nature and potentially a source
of illicit flows, see Box 3. They do nothing to help with private project finance. They also
hurt the interests of local investors. Restriction should be in the shape of higher capital
gains tax and requirement for minimum holding period.
These are small measures but together they may produce a substantial amount. Even
small amounts of less debt are a valuable goal to have. Also, this way the external account
emergency would be known and felt by decision makers and the people of Pakistan.
Taking on more debt quietly and putting the country’s future at risk may cause less ripples
now, but hardly makes a desirable national goal.

25
 Box 2: Pakistan has a very strong and credible case for debt relief

We may make a case on the following lines:

➢ Brief them on the amount of external debt incurred by the economy and how much Pakistan
has paid back as interest and principal. Net resource transfer in 20 years is negative $ 5,221
million. Over 70% of new debt is for BoP support, data from a past IPR report 16.
➢ That despite large sums paid back, stock of debt has risen greatly by 228%, even as net
transfer to Pakistan is negative in 20 years and in most years a small proportion of total
disbursed amount.
➢ That whether concessional or other creditors, share of interest in total servicing is high. It
ranges from 20% for multilateral creditors to 51% for Paris Club lenders.
➢ Where debt buildup and interest paid are concerned, concessional debt is a euphemism.
There is not much difference in cost to GoP. Concessional debt merely adds to the myth of
the usefulness of foreign debt.
The high level of debt has resulted in huge sums paid as interest to IFIs and bilateral lenders. This
is flow of scarce resources from Pakistan to creditors in rich countries. In the last five years,
Pakistan has paid annually US $ 2.3 Billion as interest, Table below. In the last 20 years, we have
paid US $ 1.4 Billion annually. In all, we paid US $ 27.2 B as interest since 2001. Of this, US $
12.9 Billion have been paid to ‘concessional creditors, IFIs and bilateral. Add US $ 1.6 Billion paid
to IMF in 20 years and we paid US $ 725 Million per year to ‘concessional’ lenders. Meanwhile,
our foreign indebtedness has grown to US $ 113 Billion, Table.

Table 5: Disbursement and Servicing of Concessional Credit FY 01-20

Million USD

Disbursed Serviced by Pakistan Net

Debt
by lender Total Transfer
stock
FY 01-20 Principal Interest Col 2 - 5

Multilateral 36,946 23,313 5,694 29,007 7,939 31,712

20% +18,402

Paris Club 2,871 5,297 5,475 10,770 -7,951 10,924

51% -921

Other 17,360 3,530 1,818 5,348 12,012 13,428

Bilateral 34% +12,977

Total Above 57,177 32,140 12,987 45,127 12,000 55,250

3 29% +30,458

Grand Total 112,644 90,652 27,213 117,865 -5,221 112,858

23% +75,699

16 IPR https://ipr.org.pk/wp-content/uploads/2021/04/Foreign-Aid-and-its-Purpose.pdf

26
 Cont’d Box 2:

➢ That the fragility of the external account limits our ability to spend on infrastructure, invest in
human capital, to acquire technology, leave alone spend on R&D or on technical skills
development. Without these inputs the economy cannot grow. Pakistan will forever be a low
growth and highly indebted economy. And it will always be an economy close to default, as it
has been for about thirty years.
➢ The Ukraine war has added to the troubles of indebted low-income economies. Barely have
we come out of challenges created by Covid when this second challenge not of our making
has hit us. The cost of the invasion of Ukraine and the sanctions imposed on Russia by the
West is borne by the whole word. This is in the shape of high energy costs, increase in food
prices (Pakistan is a net food importer), global inflation and disturbance in supply of essentials.
Already Pakistan it is difficult for Pakistan to meet the essential needs of our vulnerable
population. The fallout of the Ukraine crisis has multiplied that challenge.
➢ The unsustainability of external debt is seen from Table 5 and Figure 2-1. Figure 2-1 shows
that the economy has paid an ever-increasing amount of principal and debt, yet the stock of
debt has risen with it. Figure 2-2 shows that high debt has not led to economic growth.

Figure Box 2-1

27
 Cont’d Box 2:

Figure Box 2-2

Higher debt does not give high growth

➢ Rather than stimulate growth, high indebtedness has left us with almost permanent fiscal and
current account deficits and lower growth potential for the economy, Figures 2-3 and 2-4.

Figure Box 2-3

Fiscal Deficit % GDP 2001-2020

28
 Cont’d Box 2:

Figure Box 2-4

Current Account Deficit in Million US$

Figure Box 2-5

Growth Potential: Average annual growth by decades

The value of Rupee has fallen consistently. Rather than boost exports, which has declined
sharply, the falling Rupee has made the cost of machinery and raw materials unaffordable. Our
manufacturing and exports have suffered.

29
 Cont’d Box 2:

Figure Box 2-6

Falling Rupee Value
PKR-US$ Rate 1995-2020

Figure Box 2-7

Pakistan’s falling investment/GDP 1992-2020

All this has meant that our invest, exports and the economy’s competitiveness has fallen rapidly.
It is well below the average of similar economies in the region:

30
 Cont’d Box 2:

Figure Box 2-8

Loss in competitiveness: Pakistan’s declining export to GDP 1992-2020

Figure Box 2-9

Bank credit to private sector %/GDP

The large outflows from the country have resulted in the decline of all growth inducing indicators.
High interest payment contributes to high fiscal and current account deficits, leading to low
investment in the economy’s productive capacity, which reduces even further the economy’s
ability to service and repay its loans, which in turn encourages us to borrow more. It defies belief
that policy makers cannot see this causal nexus which has sent us into an endless loop of
dependence and impoverishment. For thirty years, we have dug ourselves into an ever deeper
and we cannot figure it out?
The paragraphs below are from IPR’s past report “Foreign Aid and its Purpose”.
IFIs have been unhelpful with their advice. Firmly in the neo-liberal fold, in the 1990s they advised
Pakistan to allow private sector in infrastructure development. The chaos it has brought to the

31
 power sector is well known. Their other projects too have had low impact. According to World
Bank evaluation, the Social Action Programme, the TARP (Tax Administration Reforms Project)
and their structural assistance loans have had mixed results. So, has ADB’s judicial reform
project. Despite their own negative evaluation, IFIs continued to lend. For example, they funded
SAP II “when SAP clearly was not working”.
Regardless, Pakistani taxpayers must pay back the loans with interest. The creditors face no
consequences.
The problem lies in the way we have used external debt. Foreign aid is used largely for BoP and
budget support. And the problem has worsened incrementally. In recent years, loans for BOP
were over 70% 0f total disbursements. The average for ten years is 61% of total, and over 20
years it is 59%. Use of foreign loans to pay back past debt is the norm. During 1989 to 1999, just
7.7% of borrowing was for BoP support. During nine years of the Musharraf government, foreign
loans for BoP support jumped abruptly to 52% of the total. This is when IFIs began ‘programme
loans’ such as DPL and PRSC i.e., Development Policy Loan and the Poverty Reduction Support
Credit. These were quick disbursing loans not linked to any project. Despite their high-sounding
goals, they had few measurable outcomes.
This happened despite very large sums of post 9/11 money received by Pakistan in the shape of
grants, Coalition Support Fund, KSA’s deferred payment for oil imports, and re-scheduling of Paris
Club loans. Despite the world’s largesse, we added few projects to leverage future growth. Since
2006, when energy prices suddenly hiked, they were used to fund oil import without passing cost
of high energy prices to consumers. During the PML N years 2014-18, much of the borrowing was
used to build Forex reserves and to keep the Rupee value high, a policy that defies logic.
So, the myth that borrowing creates growth is misplaced. In Pakistan’s case, borrowing creates
more borrowing with an external account crisis waiting to happen.
Moreover, project aid went to areas with severe flaws in project design. They resulted in weak
project outcomes. Though program/project design are government owned, lenders and their
assumed ‘quality’ inputs have more say in their design. During project implementation, lenders
closely monitor progress. Disbursements are contingent on progress. Their own evaluations show
weak to moderate impact. Despite this, disbursements continued. The loans are a burden on
Pakistani tax-payers and service users and must be repaid with interest. The lenders who have a
major say in project design take no responsibility.
Examples of weak economic impact are available in World Bank’s “Independent Evaluation
Report on its Pakistan programme for the 10-year period 1994-2003”. The World Bank is a major
source of credit for Pakistan. WB also has high level of technical and analytical sophistication.
But below is what its own independent evaluation has to say:
The report recounts the four major themes of WB lending during the period 1994-2003: i. macro
stability, ii poverty reduction and social sector uplift, iii sustainable growth, and iv governance. It
says that “outcomes of Bank assistance were unsatisfactory in poverty reduction and social sector
development, governance, agriculture and natural resource management, fixed infrastructure,
and revenue mobilization and expenditure management. Therefore, overall outcomes of the
Bank's assistance program are rated moderately unsatisfactory”17. Going into each programme
and project, the report finds serious flaws in programme design and outcome measures. During
this period, the World Bank’s IDA and IBRD disbursements totaled US $ 3.7 Billion. Pakistan still

17World Bank, Independent Evaluation Report on its Pakistan programme for the 10-year period 1994-
2003, 2006, quote taken from Page XV, discussion from many pages of document

32
 must pay for these loans that had weak impact on economic growth or citizen welfare. In fact,
their addition to the debt burden most likely had the opposite effect of what was intended.
The evaluations’ comments on individual programme or project:
Private power: As part of the Bank’s strategy to include private sector in infrastructure
development, Pakistan was the pioneer of the Bank’s energy policy. It soon had to “face the
consequences of adopting an untested set of reforms”18. Before long “a number of problems
emerged in implementation”. The report says that the issues that had encumbered Pakistan’s
power sector such as line losses, recovery, and tariff rates were well known to the Bank. The
Bank failed “to design projects that reflect the political economy and governance climate”. The
Bank’s project design did not encourage competitive pricing. It could have designed the
programme for ‘lower cost more optimal set of generation investment”. Also, “Bank management
failed to recognize the considerable risks associated with the IPP program in Pakistan, particularly
the excessive fiscal and external account risks placed on the country as a result of the government
guarantees to the private power producers” 19. The Pakistan firm and consumer has since paid a
high cost of power with no improvement in supply quality. Resultantly, Pakistan firms further lost
competitiveness.
Overall, “The Bank failed to develop realistic strategies in key areas such as poverty, rural
development, power, and governance. Although the Bank knew that commitment, sustainability,
and institutional capacity were limited and that vested interests often overruled good policy,
project design failed to take those factors into account. The Bank also failed to stick to its own
plans”. The Bank also “was slow to acknowledge mistakes (following up with SAP II when SAP
clearly was not working) and slow to address repeated problems” 20.
Similarly, TARP or Tax Administration Reforms Project of US $ 195 M and ADB’s reform of the
judiciary have had modest success. The structural assistance loans by the World Bank have been
for macro stability. In Figures 5 to 8, this paper shows charts for macro stability.
Pakistan has also received much ‘aid’ in the form of loans. Between 1998 and 2005, the World
Bank, Asian Development Bank and Japanese government lent over $500 million for a National
Drainage Program. The project was supposed to improve Pakistan’s irrigation system. However,
following complaints by local people in the Sindh region, a World Bank Inspection Panel found
that the project had led to widespread environmental harm and suffering among local
communities, violating six of the World Bank’s safeguard policies. In 2003, increased flooding,
partially caused by the project, claimed more than 300 lives. Pakistan has paid back hundreds of
million in interest and principal with hundreds of millions still to be paid.
As well as a large debt, Pakistan has huge development challenges, which are contributing to
instability in the region. Since 2010, the country has been classified as ‘middle income’. However,
its national annual income per person is only $ 1,600. Pakistan fell short of most Millennium
Development Goals and is way short of SDG targets. It is perhaps the only middle-income country
whose rank has fallen in the HDI Index. Because it doesn’t have the resources to invest in its
people.
So, classifying Pakistan’s debt as sustainable doesn’t change on-ground realities. Pakistan has
a very strong and credible case for debt relief.

End of Box 2

18 Ibid Page 24
19 Ibid Page 25
20 Ibid Page 38

33
Part 3: Analyze structural issues for medium term recommendations to put the current account
on a sure footing to avoid future such emergencies and recommend measures for structural
reforms

Structural and Medium-term measures:

Measures to deal with the budget deficit, to set aside more funds for development. These are
measures that would address key causes of the current account deficit by increasing
investment and productivity:

➢ Make power sector financially sustainable: Doing so would reduce the budget deficit and
make available funds for development.
Power sector reforms of the 1990s, done on the advice of IFIs, have led to a collapse of
power supply. Our economy could not support the cost of the ‘reforms’ that were put in
place. Also, the sector is too complex to be solved by the simple idea of private
participation in infrastructure. Having earned surplus profits, the original investors have
mostly left. It is now clear that the consumer or the government cannot meet the cost of
power along with the generous concessions that IPPs avail. In any case, because of long
delays by the government in paying tariff differential subsidy, a part of IPP profits stay on
the books for years without getting realized.
This is an unsustainable situation. Power supply has hardly improved while cost of power
has increased consistently. Government debt liability builds up and IPPs await realization
of tariff differential due to them. Everyone suffers, producers, buyers, and government.
Industrial production and exports have especially taken a hit. The previous government
carried out a study to assess how the sector can be made sustainable. Despite claims, it
fell short of opening up negotiations with IPPs.
It is time to build on the study and begin exchange of ideas with IPPs and experts on how
to make the power sector sustainable, including changes in agreements between IPPs
and government. Those who have recently acquired interests in IPPs at a price that may
have included expected profits would resist the most any change in agreement.
Government may decide to give such cases one time compensation. But it is time to make
power supply in Pakistan reliable and cost effective for business and individual consumers.
That may also remove some of the governance problems from the DISCOs.
➢ Restructure domestic debt: With 38% of total federal expenditure going to interest payment
(repayment is separate), government debt is now a huge burden on public finance. In the
first nine months of FY 22, GoP spent 76% of net federal receipts on paying interest on
debt. This is a massive cost on the people of Pakistan. Citizens pay for government’s
profligacy through taxes and poor services. We continue to borrow to pay past debts and
interest expenditure keeps growing. There are recommendations in the policy discussion
space to get debt relief by restructuring domestic debt. As proposed by an analyst, GoP
may get debt relief by either reducing interest rates on domestic debt or through reduction
in principle. ‘IMF has recently provided a comprehensive guide to (its) execution, based
on theory and experience. While the people of Pakistan have been driven to poverty and

34
 destitution, the top 10 banks reportedly earned Rs 1,400 billion in interest income, during
each of the last two calendar years’21.
Pakistan’s continued reliance on public debt may have led us to a stage where everyone
knows that it cannot be returned, but does not admit it to protect their balance sheets. “This
puts the continuation of mutually profitable creditor-debtor relations at risk …. Borrowing
must be linked to returns”22. It takes away precious resources from public funds that is best
invested in growth inducing projects.
➢ While IPR recommends increase in PSDP, there is a strong case to recast the PSDP into
one that supports exports by raising private sector productivity. Planning Commission must
develop a new metrics for selection of projects that support exports. The decline in exports
from 19% of GDP in 1990 to about 8% in 2021 is a sad travesty and a major cause of
present problems. All public investment must serve the goal of reversing this trend. Under
top level supervision, all relevant parts of the federal and provincial governments must
come together. In addition to the main players, they include HEC, science and technology,
its affiliates such as PCSIR, the IT ministry, NAVTEC, FBR, and provincial departments23.
Monetary and other measures
➢ Keep liquidity flowing: While the present tight monetary policy is understandable, State
Bank must find ways to keep credit flowing within its overall money supply target. This
could help stall the slowdown in GDP growth. Credit is very important for growth. Done
right, it could spur exports. There are a few measures to consider to enhance private sector
investment and productivity:
• Government may consider making available short- and long-term fixed rate financing
for export industry. Also, Export Refinance Facility is too restricted by its ceiling limits.
SBP may enhance ERF limits in line with devaluation of the Rupee.
• Changes in exchange rate of the Rupee has made it necessary that SBP enhance the
ceilings for Long-term financing facility.
• Similarly, SBP’s TERF became an important source of financing for industry. SBP may
restore this facility.

Credit for export and industrial growth:

➢ For decades, government has considered setting up an EXIM bank with preferential rates
for export finance and to extend concessional credit for preferred export industry. It is time
for government to establish the EXIM Bank. It may set aside a part of the Export
Development Fund to contribute to the EXIM Bank’s equity.
➢ Ease regulatory requirements to allow banks to lend more to businesses. Pakistan’s
private investment is just 11% of GDP, about half the average for South Asia. This cannot
yield meaningful industrialization in Pakistan.
➢ Find ways of increasing further credit for SMEs, though SBP has made efforts their
outcome is unclear. They currently have a share of 6.3% in total private sector credit.

21 Business Recorder, How to solve the debt crisis, Arshad Zaman 22 Apr, 2022. The writer gives a six-
step how-to on domestic debt restructuring
22 Ibid
23 The News, The economy needs rapid improvement, Humayun Akhtar Khan, 14 April 2022,

https://www.thenews.com.pk/print/950021-the-economy-needs-rapid-improvement

35
➢ To strengthen industrial growth, government must revive DFIs. Fixed cost long-term
project financing was key to industrial growth of the 1960s. DFIs have been done away
with on IFI advice. That has not served us well. The private sector needs predictable and
fixed cost project finance24.

Increases productive capacity and self-reliance

➢ Increase domestic sources of energy: The last major policy update to enhance petroleum
supply was in 2012. The last tight gas policy was in 201125. Since 2012, government’s
focus has been on import of LNG. While that is good to tide over immediate needs,
Pakistan needs a more sustainable arrangement. The Energy Information Administration
of USA which is an office under the US Department of Energy has identified Pakistan as
one of the top shale gas sources. Shale gas exploration needs complex technology with
high cost and greater risk. Pakistan must have a separate policy for shale gas cost
recovery, access to technology and risk sharing. Without such a policy, shale gas would
forever be a potential that stays unrealized. Increased production would directly help with
the current account deficit and make the supply more reliable.
➢ Similar effort is needed for other mineral resources.
➢ SBP’s recent effort for digitization of the economy will help productivity. This must continue
and other key areas must complement, especially the FBR, where refund delays often
increase cost for business. These organisations must digitize their interface with citizens
for efficient operation to reduce firm level cost of doing business. To encourage e-
Commerce, it is important to increase the de minimus limit. Meaningful e-Commerce
cannot take place within the present low limit. Also, there should be rules to encourage
Venture Capital Funds for FINTECHs.
➢ Transparency:
• No international agreements, except those related to security, should be secret from
parliament or the public. International agreements, other than security, should be
reviewed by the relevant parliamentary committee and if needed be kept classified.
Yet, they cannot stay in the corridors of the executive. There is no check on loan
agreements, including those sourced from the market. The cost of repayments is borne
by the people of Pakistan as tax payers and as consumers of goods and service. There
is no consequence or accountability of decision makers. Similarly, contracts such as
mineral exploration or large infrastructure projects remain classified. The constitution
provides for parliamentary review over finances. That has not happened.
Clearly, secrecy has not worked. It has caused much grief to the people of Pakistan in
the shape of frequent economic crises, high debt repayments, increase in cost of
essentials, high indirect taxes, poor services for the people, and unemployment.
Secrecy strengthens the negotiating hand of the other party not of Pakistan. There
should be a decision by the National Assembly that henceforth all international
agreements would be open to committee review and where possible be made open to
the public.

24 The News, The economy needs rapid improvement, Humayun Akhtar Khan, 14 April 2022,
https://www.thenews.com.pk/print/950021-the-economy-needs-rapid-improvement
25 Gas that is hard to drill for as it is locked in pockets of impermeable rock, sandstone, or limestone

formations

36
 • The above recommendation also extends for the relevant parliamentary committee to
review all new international loans before government signs them. Parliament must also
lay guidelines for incurring loans in the future. This is entirely in line with the essence
of democracy.
• National Assembly may under its auspices commence a classified study to analyze
where all past loans went. This should be done by the Auditor General of Pakistan.
The study should not lead to a witch hunt of anyone. Its purpose should be to learn
lessons from the past in order to avoid similar pitfalls in future.
➢ Especial effort to check flight of capital, see Box 3 26: In times of uncertainty and fear of
loss in value of assets from devaluation, new taxes and inflation, capital leaves for more
secure destinations. Resources earned from corruption is another source. There are also
some measures that parliament must take: See Box 3
Above is a comprehensive plan to revive the economy. The purpose of this study is to
move beyond the usual self-created boundary framing it as a discussion for incurring more
debt. This study goes to the causes of the structural current account deficit to highlight the
gaps in economic policy making of the last many years and to address these flaws.
There are a few requirements to execute such a comprehensive plan. First, political
instability must end in the interest of the country. Another matter to keep an eye on is to
not let the progress on Covid slip. And it is very important for government to deal with the
supply side measures to tackle inflation. This step is critical for citizen welfare.
This is a long list of things to do by the government and regulators. They will happen if the
government is serious in putting behind years of uncertainty and setbacks caused by weak
financial management. And if it uncompromising in correcting the many flawed policies
that together have brought us to this pass. There will be no progress, if GoP continues
with policies that serve the interest of decision makers and cronies, as successive
governments have done so far. In that case, any public statement about dealing with the
debt crisis or reviving the economy should be discounted immediately.

26There are varied definitions of capital. This paper refers to assets held by Pakistan residents not
recorded as investment or intercorporate transfer of fund by say transfer pricing.

37
 Box 3: Capital flight 27

In times of uncertainty and fear of loss in value of assets from devaluation, taxes and inflation,
capital leaves for more secure destinations. Resources earned from corruption is another source
of informal transfer. The best way to reduce the flight is for the country to have sound economic
policies and improved enforcement. That hasn’t happened in decades.
Besides this would not take care of transfer of money gained through corruption or MNC transfer
pricing and profit shifting, a major source of leakage, No one has a handle on the scale of the
problem in Pakistan. It is safe to assume that it is rife.
An IMF report estimated capital flight from a group of debt-ridden developing economies during
the years 1978 and 1988. The report estimates that during those ten years, the stock of undeclared
capital held by residents of the selected group of countries ranged between 38% and 51% of total
stock of external debt28. For many reasons, that ratio seems high in the case of Pakistan. Yet given
the total external debt stock of S 122 billion, even half of the lower estimate amounts to over $ 20
billion undeclared capital held outside.
IMF and the Centre for Applied Research, Norwegian School of Economics, and the Global
Financial Integrity in two separate studies have detailed the harmful effects of illicit transfers that
drain resources of poor countries. By redirecting resources from potentially productive uses, such
transfers diminish developing country’s capacity for growth. Their effect is more severe than what
happens when outflows are recorded29. IMF estimates that between 2001 and 2010 illicit flows
from developing countries totaled $ 5.9 trillion. Against this total ODA received by developing
economies during this period was $ 670 billion, about 11.5% of the illicit outflows30. In fact,
developing countries are net creditors for the rest of the world. GFI finds that in the 32 years
between 1980 and 2012, developing economies lost $ 10.6 trillion or $ 405 billion annually, not
including China31.
Also, there is ‘evidence that tax havens undermine national and international regulation. Tax
havens have a detrimental effect on growth in poor countries 32.’ They take away resources and
encourage rent seeking activities.

27 There are varied definitions of capital. This paper refers to assets held by Pakistan residents not
recorded as investment or intercorporate transfer of fund by say transfer pricing.
28 IMF, Risk and Capital Flight in Developing Countries, Liliana Rojas-Suarez, July 1990, Page 5
29 Financial Flows and Tax Havens: Combining to Limit the Lives of Billions of People, Centre for
Applied Research, Norwegian School of Economics, Global Financial Integrity, Jawaharlal Nehru
University, Instituto de Estudos Socioeconômicos, Nigerian Institute of Social and Economic Research,
December 2015
30 Finance & Development September 2013, Capital Flight Risk, Rabah Arezki, Senior Economist IMF’s

Research
Department, Gregoire Rota-Graziosi is a Senior Economist in the IMF’s Fiscal Affairs Department, and
Lemma W. Senbet, Executive Director of the African Economic Research Consortium and University of
Maryland, based on IMF Working Paper, “Abnormal Capital Outflows, Natural Resources, and Financial
Development.” https://www.imf.org/external/pubs/ft/fandd/2013/09/Arezki.htm
31 Op.cit 3, Table 4, page 12
32 Op Cit 3, page XIII

38
 Cont’d Box 3:

A large part of capital flight is by MNCs. A UN University study cites credible “evidence that
multinational firms reduce their tax bills considerably by shifting profits from countries with high
corporate taxes to countries with low taxes” or to tax havens. The “techniques are fairly well
understood”33. Developing countries lose valuable taxable income with adverse effect on
performance of institutions. According to IMF, globalization has made MNCs very powerful at the
expense of common citizens as they pick between regulations and tax bases.
The IMF study lists another MNC tactic that deprives developing economies of tax revenue. ‘Thin
capitalization is when a company chooses to be more indebted than similar independent entities.”
It recommends having tax rules for ‘thin capital’, that limits the amount of deductible interest 34. The
productive investment that this may cause would outweigh the measure’s deterrent effect on FDI.
MNC’s informal transfers are especially prevalent among exporters of minerals. With Reqo Diq to
come into operation soon, Pakistan must exercise care.
Also, in an environment of high tax leakage, the corporate sector is important as a source of
revenue. Therefore, losses from MNC’s informal transfers have significant effect.
There are no easy solutions. IMF and GFI recommend vigilance by tax authority and regulators.
They must keep an eye also on inflows to countries especially as portfolio investments. “High net
worth individuals and private corporations may initiate illicit flows into a developing country”35. In
Pakistan we have seen frequent examples of this with the in and out of portfolio investment, most
glaringly in 2018-19 when the SBP offered interest rates of up to 13.25% on debt flows at a time
when LIBOR was about 1%.
The OECD Common Reporting System is a useful platform for exchange of information about
cross-border bank account holdings. It enables governments to see bank account details for their
own taxpayers with wealth holdings in other countries. About 100 countries are signatories. There
are glaring exceptions. USA has placed itself in the happy position of obtaining information from
other countries through its FATCA36, but not sharing information about residents of other countries
with assets in USA. Switzerland creates difficulty for developing countries to access information.
Loopholes in CRS that allows for fake residency is another challenge, whereby information goes
to jurisdictions that are not the real place of residence of holders of assets. Shell companies make
it difficult to know real ownership of assets37.
A UNCTAD report states that by 2030 limits on informal outflows from Africa could generate enough
funds to meet “50% of the $2.4 trillion needed by sub-Saharan African countries for much-needed
climate change adaptation and mitigation measures” 38.

33 WIDER Working Paper 2016/10, revised version May 2017, Are Less Developed Countries More
Exposed to
Multinational Tax Avoidance? Method and evidence from micro-data, Niels Johannesen, Thomas
Tørsløv, and Ludvig Wier*
34 Op Cit 4, page 27
35 Op Cit 3, XII
36 The Foreign Account Tax Compliance Act (FATCA), which was passed as part of the HIRE Act,

generally requires that foreign financial Institutions and certain other non-financial foreign entities report
on the foreign assets held by their U.S. account holders or be subject to withholding on with-holdable
payments. The HIRE Act also contained legislation requiring U.S. persons to report, depending on the
value, their foreign financial accounts and foreign assets.
37 This para based on Tax Justice Network’s ‘It’s time for countries to start publishing the data they’re

collecting under OECD’s Common Reporting Standard’, Andres Knobel, 2018

38 Africa loses $89 billion a year to illicit capital flight, UN report finds, Benjamin Fox | EURACTIV.com

39
Two things are important. That capital flight in various forms is a serious enough problem for
Pakistani regulators to be concerned about. And that given the lack of transparency and the hurdles
built in to the system, it requires a high level of expertise, constant vigilance, and persistence to
capture the income to make them taxable. There must be especial institutional arrangements to
monitor and enforce.
So far, governments in Pakistan have not been serious.

End Box 3

40
 Board of Directors
Mr. Humayun Akhtar Khan, Chairman & CEO

Mr. Akbar Khan

Haroon Akhtar Khan

Mr. Ghazi Akhtar Khan

Mr. Ashraf M. Hayat, Executive Director,

Company Secretary

Board of Advisors
Dr. Atta-ur-Rehman

Mr. Abdullah Yousaf

Lt. Gen (R) Sikander Afzal

Mr. Syed Yawar Ali

Mr. Tasneem Noorani

Mr. Tariq Parvez

Dr. Manzoor Ahmad

Mr. Tariq Malik

Dr. Iqrar Ahmad Khan

Mr. Salman Raja

Mr. Ashfaq Yousuf Tola

Ms. Roshan Bharucha

Mr. Hussain Haroon

Dr. Abid Suleri

4- Shami Road, Lahore Cantt, Pakistan

UAN:111-123-586
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https://twitter.com/IPR_Pakistan

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41