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Foreign debt: net dollar outflows

Updated July 22, 2013

UNFETTERED recourse to foreign borrowing has ballooned the external debt to an estimated $6 billion on June 30, 2013. The speed with which it has grown over the past three years has turned the ‘basic’ transfer highly negative for the country.

Basic transfer measures net foreign exchange inflow and outflow related to a country’s international borrowing. It is the difference between capital inflow from external borrowings and the capital outflow arising from payment of installments plus interest on existing accumulated debt. As long as the inflow from additional borrowings is more than the outflow, and the accumulated debt is used for productive purposes, rising foreign debt stock does not pose a problem for the borrowing country.

However, a serious problem emerges when accumulated debt becomes so large that additional external borrowing is spent entirely in paying installments and interest, and nothing is left for augmenting the resources of the borrowing country. The problem may acquire a threatening posture for the economy if additional borrowings fall short of the combined liability of payment of installments and interest on accumulated past debt.

Over the past three years, Pakistan has become a classic example of extreme negativity in its basic transfer account. This is on account of our liability on servicing past debt exceeding inflows from additional debt. This trend is set out in the table.

It is clear from the table that from FY2011-12 to FY2013-14, Pakistan emerged as an exporter of capital to the developed world on account of reckless international borrowing. Its impact on fundamental indicators of the economy is too well known to repeat.

Normally, there are two options available for reversing this trend. The first is to curtail imports, step up exports and impose exchange control on current and capital accounts. The other option is to go for additional foreign borrowing to prime the wheels of the economy.

Faced with an IMF stabilisation programme, Pakistan opted for the second option, namely the abolition and liberalisation of foreign exchange and import controls, alignment of the exchange rate to market movements, a stringent domestic anti-inflation programme, and opening up the economy for trade and investment to foreigners.

Hungry for additional borrowing, like other developing countries, Pakistan accepted and implemented these policies at the expense of economic stagnation, rising unemployment and poverty.

Within the country, the policy of unleashing private initiative in all sectors of the economy — with the role of the state limited to being a promoter, catalyst and facilitator of private enterprise — created inequity in the distribution of income and wealth. This helped create a small class of the rich that came to acquire political power for amassing wealth by all means, including legislation that suited their interests, as well as by offering commissions and kick-backs on public contracts, tax evasion etc.

The wealth so amassed quickly slipped out of the country under the protective umbrella of a free and liberalised foreign exchange regime. Paradoxically, these regimes were actively supported by the developed world on account of their kowtowing of developing states to the desired policy framework of the West.

The voice of the people was kept muzzled all over the globe, including Pakistan, till the given prescription faced a severe challenge, especially after the international financial crisis of 2008, which finally also rocked the developed world. The ordinary citizens rose in revolt against the system that had created a highly iniquitous society.

Sensing this trend, many developing countries, which had been crying hoarse for long against the adverse fall-out of the global financial system on their economies, were wise enough to take the first step in defying the hitherto sacrosanct principle of free foreign exchange regime. These countries, including South Korea, Indonesia, Malaysia, Taiwan, Brazil etc., among other measures, imposed indirect exchange controls on portfolio investment by foreigners, so as to discourage short-term currency movements, euphemistically called ‘hot money’.

The developed world, including the US and the European Union, have also stepped up their efforts to bring back wealth from the Swiss banks, which was taken out of their countries by rich individuals and corporations to evade taxes.

While the world is moving on to take corrective measures against the system imposed on the globe during the 1980, 1990 and 2000 decades, we continue to tread the old path. Neither the budget for FY 2013-14, nor the Medium Term Framework for the next three fiscal years, speak about any measures contemplated for imposing exchange controls on the flight of capital (that was earned through dubious means) or about any measures for bringing back tainted money lying in the vaults of the foreign banks or invested in movable and immovable property.