April 7, 2003	Monday	Safar 4, 1424

The turnaround in the external sector has created a window of opportunity for policy makers to revamp their debt management strategy. With massive inflow of dollars, the country does not face the threat of a debt default. In a way, it is out of the debt trap. The official strategy to reduce expensive debt because of surplus liquidity and interest rate crash will help to make debt burden sustainable, for a short-term, for a weak domestic economy.

The debt management cannot be insulated from the over-all vision of economic growth, development path, industrialization and poverty reduction. To do so would mean looking at the debt problem merely from the perspective of borrowers and debtors. Critics say that the Debt Management Strategy Report (DMSR) which is expected to serve as the benchmark for shaping future policies, is lender-friendly at the cost of the borrowers.

Some of the targets by the DMSR have also been exceeded by a favourable turn of events after September 11 and its assumptions and forecasts are being increasingly questioned because many of its projections are not being realised. The net foreign direct investment inflows and yields from privatization have been much lower than anticipated. It requires a fresh appraisal of the debt strategy.

“Neither theory nor empirical evidence suggests that stablization always ‘necessarily’ leads to economic growth” says a SPDC research report on “Pakistan’s external debt burden: causes, remedies and complexities”, in a critical appraisal of DMSR recommendations. The report has been prepared by researchers Asad Sayeed and Ejaz Rashid.

Currently, for all practical purposes,the finance ministry and the State Bank seem to have adopted a single dimensional approach to tackle the external debt issue. It is to retire expensive foreign debts.

The finance ministry’s first target is to retire the IMF’s expensive debts specially the SBA (Stand By Arrangement) credit facility of around $650 million. Since the IMF loans are for balance of payments support, they are kept in the State Bank and not transferred to the government. These pre-payments would amount to offsetting the assets against the liabilities. The State Bank would however have to pay premium to the Fund for advance repayment of the loan. A debt office headed by Dr. Ashfaq Hasan Khan has been set up in the ministry of finance to draw a strategy for pre-mature repayments of multilateral debts.

In December 2002 , the State Bank of Pakistan (SBP) allowed the private sector to retire expensive debts and loans amounting to $2.1 billion with maturities ranging from 5-15 years. About half of these loans carry fixed average interest rate of eight per cent.

However, the response has not been very enthusiastic because the lenders’ reluctance to extinguish loans extended at higher rate of interest specially in an environment of falling interest rates. Or alternatively the commercial banks demand exorbitant premiums. Only few firms have applied for pre-payment of $16 million,of which the SBP allowed $13 million by end-February 2003.

The government is also exploring the possibility of pre-payment of expensive public and publicly-guaranteed external debt. Among others, loans to the IPPs were guaranteed by the government. The issue becomes more complex in cases like Hubco,which has been funded by a large number of commercial banks. Getting all the lenders on board and at affordable premiums and the legal and documentation costs make debt retirement appear to be hassle not worth undertaking.

In the absence of required fiscal space, the pre-mature repayment of the World Bank and the Asian Bank loans involve rupee borrowing. The IMF’s approval would have to be sought to either relax budget deficit targets or exclude these borrowing from the fiscal cap. The SBP figures show that IBRD credit accounted for 27 per of the total interest paid on expensive external debt and liabilities in fiscal 2003 and is expected to rise to 44 per cent by fiscal 2005.

Whereas the expensive debts are being retired because of the interest rate crash, it can also be argued that the policy to borrow cheap foreign loans have also lost much of its relevance. The economy is awash with excess liquidity with one of the lowest if not the lowest interest rates. It is time to focus on domestic borrowing.

The SPDC report on debt burden has rightly pointed out the implications of foreign borrowings. It says that external debts have to be repaid in foreign exchange and are dependent on both exchange rate fluctuations and the country’s ability to earn foreign exchange. It means that the domestic balance is achieved at the cost of potential external imbalance in the future. The developing countries have fewer degree of freedom vis-a-vis foreign exchange liabilities. “This is a risky policy option which can and should be avoided”, cautions the SPDC economists.

In early 1990s, the amortisation payments more than doubled compared to late 1980s. In this head,the largest increase was in debt servicing for long- term loans, which increased from an average of $1068 million to $1912 million. Loans amortised in the 1990s were acquired mostly in 1960s and 1970s. The surge in amortisation payments was a major reason for balance of payments crisis in the 1990s but was exogenous to policy or governance variables during that period , says the SPDC report.

Besides, the external debt stock and increasing foreign exchange liabilities impinge on fiscal deficit.

The report also notes that the tendency to borrow externally to finance budget deficit has increased since 1997-98 compared to 1980-97.

Traditionally, it adds that the governments have borrowed soft loans on low interest rates and long term repayment period. But,the net foreign exchange earnings have always been less than the debt servicing liabilities if both interest and amortisation liabilities are taken into account.

The SPDC reports offers an alternative approach to debt reduction. Some of its findings and recommendations follow:

Although Pakistan is no longer on the verge of external debt default, sustainable debt servicing requires high and sustainable growth. The medium and long term objective should be to revive investment and growth and to create a dynamic export base so that the need for external debt is minimised. High debt requirements have a tendency to crowd out investment.

The thorny issue for policy makers has been about financing a major boost in public investment. Now, a window of opportunity has been created. After keeping a part of the huge foreign exchange reserves for contingencies, the rest can be used for creating fiscal space for high levels of public investments.

Foreign debt obligations should be honoured in ways which are not in conflict with the broad development goals. The adoption of a pro-active strategic industrial policy and the development of industrial clusters are two ways in which countries have expanded their industrial and export base.

Financial sector liberalization in 1989 led to full market based auction programme for government borrowing. It assumed a quick reduction in fiscal deficits to sustainable levels. Its impact on the contrary was to sharply raise the the government’s interest bill.

Similarly, policy failures were the most important variables in increasing the balance of payments constraints. The policy framework was adopted in 1991 and endorsed by the IFIs. And the responsibility for these failures has to be shared by the donors also.