March 27, 2006	Monday	Safar 26, 1427

THE country’s economic managers say that the debt burden stands reduced substantially during the last six years as a result of prudent management. Over this period, the external debt and liabilities as shown by the State Bank on its website have declined by $2.7 billion.

This reduction includes $1.1 billion pre-payment of expensive debt ahead of schedule during January 2004 and various waivers and write-offs by the Western countries.

The external debt during 1999-2000 at $37.9 billion was culmination of large current account deficit (up to five per cent of GDP for almost two decades), stagnant exports and workers’ remittances, and a sharp fall in other private transfers during the 1990s. But these adverse trends changed during the last five years or so, especially after of 9/11.

Notwithstanding Pakistan’s fiscal austerity or prudence, the fact remains that Pakistan is financing its development programmes and even some part of its consumption needs by borrowing domestically or externally. The country is still living with net revenue deficit and negligible primary surplus. A large part of the public debt—almost 50 per cent is external.

The public debt (including the large portion of external debt guaranteed by the government) is a charge on the budget and must be serviced in rupees from government revenues; whereas external debt, both public and private, is a claim on the balance of payments and must be serviced in foreign exchange from foreign exchange earnings and borrowings.

External debt has more serious repercussions on overall debt profile. For a developing country, the current account deficit is inevitable and thus external borrowing a permanent feature of economic activity. Only a prudent management can save the borrower from serious implications of external debt.

The country has been incurring large current account deficits due to imports outpacing exports, not enough remittances and other transfers. In the In the recent past, financing of these external deficits have created an external debt problem beyond manageable limits. Pakistan has made strenuous efforts to manage foreign savings to finance its investment demand but has not been able to achieve self-reliance.

The imprudent utilization of foreign resources has resulted in the accumulation of a large and unsustainable external debt without the capacity to service it. More ironical is the trend of using external borrowing for unproductive purposes. It was only in FY 2000 that an effort was made to manage the external debt.

The external debt problem took the shape gradually. In the decade of the 1980s, the external debt stock got doubled from $11.4 billion in 1980-81 to $22.35 billion in 1989-90 or 40 per cent of GDP to 56 per cent of GDP during the same time period.

During the 1990s, the debt stock further increased from $25 billion to $34 billion while its GDP ratio increased to 61 per cent in 1998-99. The total stock of external debt and foreign exchange liabilities grew at an average rate of 7.4 per cent per annum during 1990-99 – rising from $20.5 billion in 1990 to $38.9 billion by end June 1999 but declined slightly to $37.9 billion in 1999-2000. It showed a declining trend thereafter and the major decline was on account of foreign exchange liabilities primarily as a result of encashment of foreign currency accounts (FCA).

Foreign exchange earnings, on the other hand, either remained stagnant or increased at a snails’ pace during the same period. Despite the accumulation of over $18 billion debt in the 1990s, foreign exchange earnings rose by only $4.0 billion. Consequently the debt burden (external debt and foreign exchange liabilities as a percentage of foreign exchange earnings) rose from 240.2 per cent in 1989-90 to 347.0 percent in 1998-99.

Net foreign exchange earnings (also termed as non-debt creating inflows) always remained less than debt servicing requirements. Between 1985 and 1992, the ratio of debt servicing to foreign exchange earnings was in the range of 19 to 33 per cent. Thereafter, it increased continuously between 1993 and 1999.

If net figures, excluding foreign currency accounts (FCA’s) are considered, the debt crisis started in 1992 and peaked in 1999 when Pakistan received some respite from the Paris Club.

Many factors including considerable deceleration in worker’s remittances, stagnant exports, other transfers, and increasing interest and amortization liabilities of external debt incurred in the past contributed to this massive build-up.

Workers remittances which remained higher than exports during 1980s declined from 6.9 per cent of GDP in 1991 to 2.8 per cent of GDP in the 1998. The growth in exports in the 1991-98 period plummeted to 2.7 per cent per annum compared to 10.2 per cent per annum in the 1985-90 period. On the positive side, non-debt creating inflows foreign direct investment (FDI) increased substantially in the 1991-98 crossing the $1 billion mark during the year 1995-96.

Portfolio investment jumped from an average of $134 million per annum in the second half of the 1980s to $458 million in the 1991-98 following greater capital and current account liberalization. But since nuclear blast of May 1998 and a row with independent power projects (IPPs) FDI and portfolio inflows declined substantially and outflows on account of profits and dividends in the current account were higher than the inflows.

The pattern of change in the external debt differs fundamentally between the decade of the 1980s and the 1990s. During 1980s, the cumulative increase in the ratio was about 13.5 percentage points, whereas in the first half of the decade of the 1990s there was an overall fall of 5.7 percentage points.

The second half of the 90s again saw a dramatic increase in the foreign debt burden more so due to the servicing costs. There had been greater success in curtailing the external debt burden in the first half of the 1990s despite the sharp fall in the real economic growth rate because exchange rate depreciation and not in the size of the current account deficits.

During the 1980s, Pakistan followed an aggressive exchange rate policy which led to increasing under valuation of the rupee in terms of purchasing power parity, and the real exchange rate fell on average each year by as much as 2.8 per cent. This implied major capital losses and rapid increases in the rupee value of external debt. On the contrary, during the first half of 1990s the rupee moved, more or less, in line with changes in purchasing power parity with only marginal changes in the real effective exchange rate.

The second half of the 1990s saw massive devaluations which enhanced the rupee value of external debt. This half also witnessed substantive rise in the quantum of interest payment liabilities and non-interest current account deficit. The current account deficit was there during the 1980s but the interest rate on external debt was lower than the real economic growth while during the second half of the 1990s, the interest rate on external debt was higher than economic growth.

In the past six years, the country witnessed unprecedented exchange rate stability, high double digit growth in exports, massive inflow of remittances, current account surplus ( four out of six years), higher economic growth (last three years), low fiscal deficit below four per cent and above all, macroeconomic stability.

Pakistan has succeeded in not only arresting the rising trend in the external debt and foreign exchange liabilities which have declined by $2.7 billion – down from $37.9 billion in 1999-2000 to $35.2 billion by December 2005. On the other hand, foreign exchange earnings more than doubled from $12.7 billion in 1999-2000 to $26 billion in June 2005.

The surplus in current account coupled with a continued build-up in foreign exchange reserves and the higher and rapidly growing foreign exchange earnings, the pre-payment of expensive debt and debt write-off are the major factors responsible for the reduction in the total stock of debt. On the other hand, high double digit growth in exports, buoyant FDI inflows, extraordinary inflow of workers remittances are the major factors for exponential growth in foreign exchange earnings.

In terms of the GDP percentage, external debt and liabilities was 51.7 per cent of GDP in end-June 2000, declined to 36.7 per cent in end-June 2004 and further to 32.5 per cent by end-June 2005. It has further declined to 28.5 percent in end-December 2005 of the projected GDP for the year. Similarly, external debt and liabilities as a percentage of foreign exchange earnings were 297.3 per cent in 1999-2000, declined to 164.6 per cent in 2003-04 and further to 137.2 per cent by end-June 2005.

Pakistan was also able to improve its maturity profile of the external debt by reducing substantially the proportion of short-term and commercial buying as well as prepayment of expensive debt. It is still confronted with adverse impact of appreciation of various currencies vis-à-vis the dollar.

For example, Asian Development Bank is one of the leading suppliers of credit among multilateral agencies and its payback requirement is in yen and the considerable appreciation of yen has made the payment more costly. This sort of currency appreciation has cost Pakistan nearly $2 billion during the last three years.

It is the time that Pakistan should manage external debt in a more professional and prudent manner through currency hedging and diversification of debt instruments along with assessing need for external financing in judicious manner. Otherwise, we would not be successful in reducing external debt burden. The Debt Office in ministry of finance has to play a proactive role to bringing external debt burden to a sustainable level.