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BW Businessworld

Onward To Insolvency

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It is well known that Pakistan's economy has done badly for years. The primary reason is that its balance of payments has been precarious, and that it has been living on the generosity of foreigners. One factor behind this dire situation is that its government has been most undisciplined and run enormous fiscal deficits. It has had what it thought was a good reason to do so, namely the possibility of an attack from India, and it may feel justified in its profligacy because it has so far avoided the attack. But as any Indian knows, only a lunatic would court a nuclear war with Pakistan, and India is not yet ruled by a lunatic. So it has been a pointless bonfire.

When a country gets doles or borrows from international institutions, they expect it to use their bounty sensibly; every once in a while they come and check whether it has done so. As Wikileaks proved, they found that it had not done so — that it had blown up America's economic aid on its armed forces. Lenders would also worry about whether Pakistan can repay its debts. To reassure them, Pakistan has published a Debt Policy statement, which is revealing in its way.

In the past six years, the ratio of Pakistan's public debt to gross domestic product has fluctuated around 55-60 per cent. That is not extraordinarily high by world standards. Greece's ratio last year was 130 per cent; Italy's, 115 per cent. These are basket cases, but countries in no immediate danger of default have much higher ratios. For example, Germany's ratio last year was 74 per cent, France's 84 per cent, Singapore's 99 per cent, and Japan's, 225 per cent. If the debt-GDP ratio were the only criterion, it is difficult to see why Pakistan is in such trouble.

Maybe it is because Pakistan's external debt is too high. Actually, it has been somewhat smaller than domestic debt; its ratio to GDP has been 25-30 per cent. This is peanuts; São Tome and Principè's ratio is 349 per cent, Liberia's, 590 per cent, and Ireland's, 1,103 per cent. Even if we leave out basket cases, Switzerland's ratio is 229 per cent, Hong Kong's, 334 per cent, and Britain's, 400 per cent.

Dividing by GDP is an elementary way of making figures for different countries comparable, but when it comes to debt, it is crude. After all, public debt is debt of the government, it has to be in a position to repay the debt, and its capacity to repay depends on its revenue. Pakistan's public debt has been roughly four times as high as its revenue. So even if the government were to repay the debt over 20 years, it would have to use a fifth of its revenue to do so. If it were to pay 10 per cent interest on the debt, its debt service ratio would come to 60 per cent of its revenue; that would be drastic.

Actually, Pakistan's situation is so dire that it would not think of retiring its debt; it only has to worry about the interest payments, plus the short-term loans it has to repay. Its debt service ratio was 30 per cent in 2006-07; five years later it had risen to 40 per cent.

In all the above comparisons, I implicitly held the exchange rate constant. Actually, Pakistan's payment situation is so dire that its Rupee is being devalued all the time; and devaluation increases the burden of the foreign debt in domestic currency. In the past year, 20 per cent of the increase in debt was due to currency depreciation.

Although Pakistan's debt looks small by world standards, its government finds it difficult to find buyers for it. In 2005-06, 22 per cent of the borrowings were against what Pakistan government euphemistically calls market-related treasury bills; in 2010-11 their share had gone up to 26 per cent. These are treasury bills the government notionally sold to the State Bank of Pakistan. Since it owns the bank, these treasury bills only transfer money from one of its pockets into another. It lends to itself; more accurately, it prints money.

It can print Rupees, but it cannot print dollars or euros; foreign loans have to be repaid on maturity. That comes to a tidy sum. Interest payments come to only about 3 per cent of foreign exchange earnings. But repayments come to 15-17 per cent. So about a fifth of foreign exchange earned has to be spent on debt servicing. The repayments to disbursements ratio was 45 per cent in 2008-09; in the next two years it rose to 71 per cent; Pakistan is borrowing to repay old debts.

The fact that most foreign debt is short- to medium-term and has to be repaid on time makes the government anxious to have foreign exchange in hand. That plus the lower interest rates on foreign loans make it eager to borrow abroad. That is what keeps the Pakistan government on a foreign exchange tight rope.

The author is Consultant Editor of Businessworld.


(This story was published in Businessworld Issue Dated 19-09-2011)