December 25, 2006	Monday	Zilhaj 03, 1427

HUGH Dalton in his book titled “Principles of Public Finance” had deprecated the tendency of the living generation for debt accumulation, based on a questionable reasoning that “what posterity has done for us that we shall do so much for posterity?”

Perhaps, our living generation is a classic example which steadfastly clings to this reasoning for debt contracting. Since mid-1950s in the name of development, policy makers have mortgaged our assets with foreign lenders, euphemistically called “donors”.

The rationale for borrowing was that in a poor country like Pakistan domestic savings being low, foreign savings were necessary to bridge the gap between domestic savings and planned investment for raising the national income and thereby, lowering poverty.

With this mind–set, our rulers were so obsessed with raising loans that our outstanding foreign debt which stood at an abysmally low level at $24 million in 1954-55 and just $145 million or 3.87 per cent of GDP in 1959-60 increased exponentially to $4,022 million in 1972-73 or 28.2 per cent of GDP.

Recognising the trend, the authors of the 1973 Constitution were wise enough to take notice of this calamitous course that we were treading. In order to check the government from reckless borrowing, the authors inserted Article 166 which reads: “the executive authority of the Federation extends to the borrowing upon the security of the “Federal Consolidated Fund” within such limits, if any, as may from time to time be fixed by Act of Majlis-e-Shoora (Parliament) and to the giving of guarantees within such limits, if any, as may be fixed”

The wisdom of the authors however was ridiculed by the successive rulers by not enacting any Act to put a limit on borrowings until Fiscal Responsibility and Debt Limitation Act was passed by the Parliament in 2005. Meanwhile, our external debt climbed from 28.2 per cent in 1972-73 to 48.9 per cent of GDP in 1994-95 and stood at $35.8 billion or 32.5 per cent of GDP in 2004-05.

This reckless borrowing had four negative effects on our economy. First, a sizeable chunk of the budgetary revenues were spent on the servicing of our debts. Second, an inflow of foreign loans increased money supply in the economy, creating an inflationary trend. Third, in order to stem inflationary impact of foreign borrowings, the State Bank of Pakistan took sterilisation measures, thereby raising interest rates.

Fourth, what is most important is that foreign borrowings provided a leverage to foreign lenders not only to macro-manage but also micro–mange our economy. This diluted our economic sovereignty for taking independent decisions on resource allocation, choice of investment, revenue bases for taxation, rates of duty on imports and exports, input and output pricing etc.

Basically, negative public savings forced the government to borrow domestically or from abroad for meeting targeted investment. This led to accumulation of both internal and external debt. The Fiscal Responsibility and Debt Limitation Act 2005 provides for elimination of the revenue deficit by not later that June 30, 2008 and to pull down total public debt (domestic and foreign) to 60 per cent of GDP by June 30, 2013. However, the Act does not lay down separate ceiling for reduction in lethal foreign debt.

In December 2001, the government succeeded in getting its total debts of about $12.5 billion rescheduled with $8.5 billion representing the official development assistance and $4 billion representing non–ODA portion.

The rescheduling enabled the government to substantially reduce its debt servicing liability, an account of reduced payment of mark-up on the rescheduled debt and deferment of payment of instalments of the principal amount for 15 years for the ODA portion and five years for the non-ODA portion.

Following passage of Fiscal Responsibility and Debt Limitation Act, 2005 the level of total debt has increased in absolute terms by Rs266 billion in 2005-06 compared with 2004-05. This absolute increase in the stock is shared to the extent of Rs160 billion in external debt including foreign exchange liabilities.

The Economic Survey 2005-06 and now the Annual Report of the State Bank of Pakistan 2005-06 justify this increase in the debt stock in terms of GDP by declaring that “in fact the fiscal responsibility act envisaged debt to GDP ratio at 60 per cent by FY13.Since this target has been surpassed by FY06, there is no need to lower target for future”.

Furthermore, the report paints a comfortable debt servicing ability in spite of an absolute increase in the stock of foreign debt on the ground that ratios of debt to Foreign Exchange Earnings (FEE) and debt servicing to FEE have declined in 2005-06. No doubt, the trends in 2006-06 in terms of ratios may be positive but forecasting future trends on this basis is not based on sound logic.

It should be reckoned that the level of foreign debt and foreign exchange liabilities in terms of GDP has declined in 2005-06 but still it is pitched at an uncomfortable level of 29.1 per cent of GDP. If we continue to borrow more and the rate of growth in GDP is not maintained at 6.6 per cent as recorded in 2005-06, the debt-to-GDP ratio may go up, exposing us to the risks encountered in 1990s.

The World Bank has already projected a lower growth at six per cent during the current fiscal year. This apart, a complacent note does not take into account the breathing space provided to us by the debt rescheduling. The other factor which can throw a spanner in our complacency in future years is an increase in size of our existing external debt stock following weakness of dollar against other major currencies and hence the ratio of external debt to GDP.

At the same time with about 25 per cent of our debt stock on floating rates, a rise in Libor or US rates may raise our debt servicing burden. Besides, devaluation of the rupee which may be imminent due to rising trade imbalance may not only raise our debt stock but also cost of debt servicing.

Unmindful of these variables, if we continue to borrow and accumulate foreign debt on the basis of favourable ratios to-day, we will not only be violating the spirit of Fiscal Responsibility and Debt Limitation Act but also mortgaging our future generations with the foreign lenders.

The writer is a former additional secretary of the federal government