Pakistan's Public Debt: A brief overview-I

EMMA XIAOQIN FAN

ARTICLE (May 29 2007): Public debt is an important means of bridging government financing gaps. Effective and efficient utilisation of public debt can increase economic growth and help a government to achieve its development and social objectives. However, public debt is also a doubled-edged sword.

Excessive reliance on public debt and inappropriate public debt management raise macroeconomic risks, impede economic growth, and hinder economic development. For example, high public debt demand can increase the domestic interest rate thereby crowding out private investment.

An escalating external public debt stock increases the probability of default, raising the interest risk premium charged by creditors. High interest payments further enlarge a country's public debt obligations, accelerate budget outlays, and squeeze capital investment and social expenditure.

In extreme cases, governments can be forced into defaulting on public debt, which tarnishes a country's international reputation and makes further borrowing difficult, whereas magnetisation of public debt generates high inflation. Both of these actions are likely to precipitate capital flight and spark financial crisis.

This note briefly examines the public debt situation in Pakistan. The objective is to understand the assistance from multilateral sources, especially from the Asian Development Bank (ADB), in a broader context. The note pays particular attention to external public debt in the country.

2. PUBLIC DEBT SOME CONCEPTUAL CONSIDERATIONS: Public debt can be examined from the sources, the uses, and debt management perspectives. In debt financing, government can borrow from a number of sources, including the central bank, domestic commercial banks, domestic non-bank sectors, and external sources.

Government usually utilises a number of options at the same time. Public debt raised through different sources has different macroeconomic implications. Borrowing directly from central banks is equivalent to printing money. It increases the high power money which in turn translates into monetary expansion.

This approach is thus highly inflationary and generally discouraged. Borrowing from domestic commercial banks is less inflationary, although it may crowd out private investment. Government borrowing from the non-bank private sector has no effect on the money supply and hence no implications for interest rates and inflation from the supply side. However, the debt held by people can exert an upward pressure on interest rates from the demand side. Borrowing from abroad has become a major feature of developing countries. Foreign borrowing allows a country to invest and consume beyond the limit of current domestic production, and can be conducive to economic growth. However, excessive reliance on foreign borrowing exposes a country to numerous risks (Hanif 2002).

THE USE OF PUBLIC DEBT ALSO HAS ECONOMIC IMPLICATIONS: Generally speaking, financing capital and development related projects can help a country to build its production capacity and facilitate economic growth. In particular, borrowing from external sources enables a country to finance capital formation not only by mobilising domestic savings but also by tapping into foreign capital surplus.

Foreign borrowing can thus lead to more rapid growth. For example, Siddiqui and Malik (2002) found that foreign borrowing increased resource availability and contributed to economic growth in South Asia. However, excessive foreign borrowing and its improper use generate severe debt service obligations and can constrain economic policies and growth.

A country's debt management program needs to take into consideration both the source and use of loans so as to raise and utilise the debt in ways that benefit a country's long-term development. Debt management is the process by which the government aims to acquire and utilise the debt efficiently and effectively. Debt management strategies not only need to explore new and cheap sources of finance, but also to consider the proper use of borrowed funds.

The technical aspects of debt management focus on the need to determine the level of financing requirements and to ensure that the terms and conditions placed on borrowers are commensurate with their future debt servicing capacity. The institutional aspects of debt management deal with organisational, legislative, accounting, and monitoring aspects of new borrowing as well as the total stock of debt. The availability of funds and the market conditions are important for the choice and design of borrowing instruments (Hanif 2002).

A key to external debt management is debt sustainability. This term refers to the level and combination of debt which allows a country to meet its current and future debt service obligations in full, without recourse to debt relief and rescheduling, and avoiding accumulation of arrears. Sustainability of debt is a situation where the debt-to-income ratio declines, or at least, remains constant over years.

A general consideration is that for the debt ratio to remain unchanged, the budget deficit does not have to be zero, but it must not push the debt to increase faster than GDP. Thus, the conventional wisdom does not consider public debt per se as a major problem. Rather, the core problems are the mismanagement and/or unsustainable nature of public debt (Hanif 2002).

There are various indicators for determining a sustainable level of external debt. Broadly, there are two types of debt indicators that assess the country's debt sustainability position: solvency and liquidity indicators. The solvency indicators include ratios such as debt to GDP, debt to foreign exchange earnings, debt servicing to foreign exchange earnings, and the public debt service to current fiscal revenue ratio.

These measures reflect the country's ability to service its external obligation on a continuing basis. The liquidity indicators include ratios such as reserves to short-term debt and reserves to total debt. They reflect a country's liquid assets that affect the ability to service its immediate external liabilities.

(To be continued)

(Emma Xiaoqin Fan is a Senior Public Resource Management Specialist in the Pakistan Resident Mission of the Asian Development Bank.)

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