Revisiting debt cap law

Published February 1, 2016

HAVING failed to achieve its key objectives in 10 years, the Fiscal Responsibility and Debt Limitation Act of 2005 is up for review again.

The law, introduced by then Prime Minister Shaukat Aziz, stipulated gradual reduction in public debt every year and then to keep it below 60pc of GDP under all circumstances proved ineffective, except for a couple of initial moves.

The government has started talks with the International Monetary Fund (IMF) seeking its technical assistance to strengthen the law to ‘provide better policy guidance and anchor debt sustainability,’ explained Finance Minister Ishaq Dar.


The government has started talks with the IMF seeking technical assistance to strengthen the law to provide better policy guidance and anchor debt sustainability


In his view it was time to evaluate its efficacy in meeting its basic objectives and also to ensure that it was in line with the emerging international best practices.

“We have sought the Fund’s advice on options to strengthen the FRDL Act in terms of operational and procedural aspects, such as an appropriate fiscal policy anchor, medium-term orientation of the budget process, and policy coordination across all layers of government,” said the minister. He added that it was also working to improve the policies and procedures for government guarantees and risk management, even though the size of these guarantees at about 2.3pc of GDP was manageable.

The exercise should enable the government to follow international best practices to systematically account for the fiscal costs and contingent liabilities associated with the broader public sector operations including SOEs, public-private partnerships (PPPs), and special purpose vehicles (SPVs).

However, the IMF’s debt projections in Pakistan’s case have not been consistent. For example, it has estimated Pakistan’s external debt at $70.2bn by end of current fiscal year in its latest quarterly report released early this month. Only a quarter earlier, it had estimated the external debt at $67.9bn for the same period.

At the start of IMF programme in September 2013, the Fund had projected $58.6bn external debt by end of fiscal year 2015-16. This variation was despite substantial savings (about $5.5bn) in oil import bill because of historic fall in global crude prices that were not in sight at the time of earlier estimates.

Similarly, the IMF had projected in 2013 that total public debt would increase to 63.6pc of GDP by end of fiscal year 2015-16 unless reform programme was pursued and it fell below 61pc.

In recent months, the IMF has been praising the government for staying on the reform course, but revised its projection for debt-to-GDP ratio to 65pc by end of this year — even worse than its projections under no-reform scenario.

The IMF projections about the debt situation are not based on the foreign loans arising out of $46bn China-Pakistan Economic Corridor (CPEC) because most of its details were still to unfold. Former finance minister Dr Hafiz Pasha, however, believes the country’s external debt would cross $90bn by 2020 and the nation would need $20bn a year for its servicing.

The IMF, however, takes a cautious position and expects the country’s overall public debt to fall from 64.9pc of GDP to 55.2pc by 2021 provided Pakistan continues with fiscal consolidation and structural reforms over the medium term.

In IMF’s view, Pakistan’s debt dynamics were particularly vulnerable to economic growth — primary balance slippage and interest rate shocks — because of the significant reliance on short-term debt, highlighting the need for sustained fiscal consolidation.

The Fund has argued that the public debt dynamics have improved over the past few years but remain vulnerable to shocks. Before the IMF programme, Pakistan’s debt-to-GDP ratio was on an upward trend as a result of large fiscal deficits, although debt dynamics benefited from low effective real interest rates provided by central bank financing. However, significant fiscal consolidation helped reverse this adverse trend.

The total public debt currently comprises only those of the federal and provincial governments, but without accounting for state-owned enterprises (SOEs) which currently account for 2.3pc of GDP.

Also, the domestic funding remained reliant on short-term instruments, but active debt management has improved the maturity profile, the IMF has noted.

The share of short-term domestic debt (less than one year) remained close to 50pc, albeit declining significantly from 64pc in 2013, as the authorities made improvements in debt management.

Although domestic funding remains reliant on short-term debt and various national saving schemes, these instruments have a relatively captive investor base. On the external debt front, the authorities have issued more marketable securities as part of their diversification strategy, but bonds and bank private creditors still account for only about 3pct of the total.

Published in Dawn, Business & Finance weekly, February 1st, 2016

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