THE recent, only partly successful, attempt by Pakistan to issue a sovereign Eurobond has had a silver lining: it has focused attention on the government’s flawed strategy being pursued under the IMF programme. The IMF-crafted macroeconomic stabilisation strategy being diligently applied since 2013 is raising serious concern among independent observers. A real and present danger of the approach being followed — not the objective of stabilisation itself but the self-defeating and myopic manner in which it is being pursued — is that Pakistan could find itself in a worse position a few years down the road than when it started the current programme.
Following through on the advice of the Fund, one of the main casualties, among a few others, will be Pakistan’s overall debt situation.
One of the principal pillars of the IMF programme is the rebuilding of Pakistan’s international liquidity. Before the start of the Fund programme in September 2013, official forex reserves had dipped to $5.2 billion; in net terms the figure was significantly lower after adjusting for the swaps and forward position of the central bank. Two years later, by virtue of the releases from the IMF, inflows from other multilateral agencies and donors, a generous grant from Saudi Arabia, spot buying by the State Bank from the inter-bank market, and large doses of commercial borrowing, official reserves have risen to $15bn.
Decomposing the main sources of forex reserves accumulation, it is clear that the 50pc fall in international oil prices, combined with declines in other commodity prices, has given a very substantial boost. If oil prices had remained at the same level as in end-September 2013 throughout this period, and keeping other factors constant, Pakistan’s forex reserves would have been around $3bn to $4bn lower than currently.
The political economy favours contracting new debt.
Out of the remaining $6bn increase in the State Bank’s forex holding in the last two years, external borrowing, mainly commercial, accounts for approximately 70pc of the increase. In comparison, the country’s exports, which should be the main driver of forex reserve accumulation, have declined by over $700m over the past two years.
In overall terms, since July 2013, non-debt creating foreign exchange inflows (such as foreign direct investment, remittances and exports) have increased by $2.2bn, while debt flows have increased by $4.1bn (in net terms).
While Pakistan’s overall external debt situation is not alarming at the moment, with the bulk of the debt stock long-term and concessional in nature, and with debt repayment indicators in a relatively comfortable zone, the trend established in the past few years does give cause for concern.
The concern is accentuated by the possible confluence of a number of unfavourable factors in the medium term. Within the next three years, repayments begin on maturing sovereign dollar-denominated bonds; to the Paris Club on rescheduled debt; and to the IMF for the amounts disbursed under the current programme. In addition, imports relating to new power plants and the projects under the China-Pakistan Economic Corridor will also kick in. On top of all this, Pakistan could be incurring as yet unspecified external liabilities on CPEC projects.
With exports misfiring, the government paying inadequate attention to this cause, and remittances plateauing, the unfolding scenario could be the ‘worst case’ rather than the hopeful ‘base case’ constructed by the government and IMF.
(A crude indicator of the PML-N government’s priorities is the number of hours the finance minister has spent travelling the world meeting foreign bond investors in the past two years versus the amount of time he has given to Pakistan’s exporters in listening to, and trying to address their concerns.)
Taking external as well as domestic debt together, Pakistan’s debt dynamic in overall terms is extremely unfavourable. Public debt has increased nearly three-fold since 2008, rising to almost Rs18 trillion by end-June 2015, growing at a compounded annual rate of over 16pc. In the last two years, Rs3.2tr has been added to the public debt, increasing the stock by 22pc. Making the debt dynamic non-benign is the fact that the bulk of the increase (Rs2.7tr) has come from high-cost, shorter-maturity domestic debt.
With economic growth stagnating, inflation-adjusted increase in government revenues only nominally positive, and uncertain prospects for exports, the outlook for public debt is not benign. Already, public debt-to-GDP ratio stands at over 65pc (excluding the quasi-fiscal deficit), well above its legal threshold under the Fiscal Responsibility and Debt Limitation (FRDL) Act of 60pc. Interest payments are inching up, budgeted to consume 52pc of total net federal revenue (after provincial transfers) in the current fiscal year.
An oft-overlooked aspect of Pakistan’s debt situation is the political economy. There is an inherent asymmetry between the ‘benefits’ derived from new debt undertaken, and the burden of its repayment. There are two facets worth considering. First, those segments who tend to ‘benefit’ from the debt contracted (the elite) are usually different from those who bear the incidence of the debt burden (the less affluent).
The elite benefit from the country’s overall borrowing because it insulates them from difficult choices by easing their budget constraint. The debt expands their available resource pool, and their control and influence of expenditure allocation allows them to increase the spending on their constituencies while shifting the ‘burden’ and consequences to less influential segments. The consequences can be in the form of expenditure cutbacks, lower spending on public services, lower investment and growth in the economy and/or higher inflation.
The second aspect is the inter-temporal and inter-generational nature of debt. An earlier generation (or one political government) can raise the debt, reap the ‘benefits’ of debt-fuelled growth, and then pass on the repayment burden to the next generation (or next government).
In the presence of such incentives, and Pakistan’s rich history of debt accumulation and fiscal indiscipline, it is difficult to be sanguine about the debt outlook.
The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.
Published in Dawn, October 16th, 2015