THE centrality of fiscal policy in growth and development cannot be overstated. The government, through its taxation and spending instruments, has the ability to ensure an equitable economic growth.

This is primarily achieved through three key channels: using appropriate tax and transfer schemes such as social security; subsidising sectors to compete in the international market; and providing goods and services which are socially desirable but will be underprovided if left to the private sector.

However, an important factor that is necessary for the fiscal-growth nexus is the practice of prudent fiscal policy. Excessive debt limits fiscal policy since a large proportion of existing revenue is spent on servicing debt.

This is not necessarily a problem for countries that are growing quickly with capacity to refinance maturing debt and clear interest payments every year.

Several indicators point towards a need for an organised fiscal consolidation together with the overhaul of tax machinery. The reformation of PSEs must be taken seriously

But this is not always the case. A recent crisis in Argentina is a good reminder of how a sudden collapse in investor confidence is almost impossible to reverse. A drastic increase in domestic interest rates from 27.25 per cent to 40pc remained insufficient to discourage investors from selling peso (Argentina’s currency). To calm investors, the government had no option but to, once again, resort to the International Monetary Fund (IMF).

Pakistan is all too familiar with such crises. Yet, short-term gains always outweigh long-term costs. IMF estimates suggest that Pakistan’s gross financing needs (ie new borrowing requirements to finance the budget deficit and the maturing debt) stand at 30pc and 31pc of GDP in fiscal years 2018-19 and 2019-20, respectively. This is significantly higher than 22pc in 2011-12. In contrast, average financing needs for other emerging and middle-income economies have remained less than 10pc over a similar period.

Worse still, the proportion of gross financing needs going towards financing maturing debt has also increased from 76pc in 2010-11 to an expected 82pc in 2018-19 and 2019-20. This has not emerged as a significant problem so far. Falling interest rates — in both international and domestic markets — meant Pakistan could refinance maturing debt at a decreasing cost.

Low interest rates in the international market also encouraged the government to increase its reliance on external financing. Government’s external financing almost tripled from an annual average of around Rs150bn before 2014-15 to more than Rs400bn thereafter.

However, recent developments in international and domestic economic environment pose a number of macroeconomic risks, and therefore require an immediate policy response.

First, interest rates in the international market have started to rise. The interest rate on the 10-year US government bond recently hit 3pc for the first time since 2014, and is expected to continue rising.

This means that next time the government decides to refinance debt by issuing a Eurobond, the cost of refinancing will be significantly higher than the 6.875pc it paid on a 10-year bond in FY2018 (down from 8.25 in FY2014). Higher debt levels, combined with an increase in the likelihood of a balance of payment crisis, will make investors demand a much higher premium than before.

Second, and primarily driven by dwindling foreign reserves, the exchange rate peg has been abandoned resulting in an immediate depreciation of the rupee. This means that, in rupee terms, interest payments will increase. The State Bank’s report on ‘State of Pakistan’s Economy’ shows that interest payments increased by more than Rs100bn during the first half of FY2018.

Third, domestic interest rates are also expected to rise. An increase in oil prices in the international market and strong growth in the domestic economy is going to exert an upward pressure on domestic inflation. Year-on-year core inflation has already increased from 4.1pc in March 2018 to 7pc in April 2018. If these developments continue to move in the same direction, the State Bank will respond by increasing domestic interest rates.

An obvious fiscal implication of factors mentioned above is a significant increase in refinancing cost of maturing debt. These risks will adversely affect the usefulness of fiscal policy towards ensuring equitable growth. An increase in the cost of debt servicing will force the government to limit spending in areas which are crucial for expanding the long-run potential of the economy and/or may be critical from an equity perspective.

These indicators point towards a need for an organised fiscal consolidation, together with the overhaul of tax machinery. The reformation of public-sector enterprises must be taken seriously. The government should consider going back to Dr Ishrat Hussain’s work on government institutions that have lived beyond their purpose and are an unnecessary administrative and financial burden on the economy. However, with elections around the horizon, there is little hope on this front.

Dr Irfan A. Qureshi is an assistant professor of Economics at Lums

Dr Ahmed J. Pirzada teaches at the University of Bristol and Queen Mary University of London

Published in Dawn, The Business and Finance Weekly, May 21st, 2018