On the surface, the ocean is calm. But deep down, it is turbulent. Pakistan’s current account deficit is down, its balance of payments has ballooned.

Overall growth in the government’s domestic debt and liabilities is slowing down — only after quadrupling of debt generation via long-term Pakistan investment bonds (PIBs) within a year.

The half-yearly fiscal deficit is lower than feared. But it will surely surge in the second half owing to anticipated fiscal slippages and a heavy cost of domestic debt servicing. Domestic debt servicing is still eating up more than 30 per cent of the government’s total expenses. Our treasury bills offering a very high return are attracting lots of foreign investment — or hot money. But the cost of external debt servicing is on the rise. The federal government has retired lots of previous debts of the central bank but only after amassing commercial loans. Banks continue to ignore credit demand — whatever is left of it amidst stagflation and high interest rates.

The PTI government has remained critical of the previous government’s policy of keeping the rupee artificially stable and rolling out big-ticket infrastructure projects while ignoring the fiscal deficit. Now its own policy leading to the quadrupling of domestic investment in long-term PIBs just to keep short-term liabilities look leaner is coming under question: its undying craving for hot money has also raised questions about the quality of external debt management.

The government’s reliance on the central bank for generating dramatically high non-tax revenue may upset the ideal equation between fiscal and monetary independence

Debt management is always difficult — more so if the managers also have to make the trade-offs they don’t like. It is easier for the opposition parties to challenge the wisdom — and often the intent — of the government of the day for bad debt management. But when the same parties get a chance to run government, they soon learn how difficult it is to keep domestic and external debts at prudent levels, avoid defaults and rein in fiscal- and external-sector gaps — without taking a hit on one economic fundamental or the other.

In July-January, the current account deficit shrank to $2.65 billion from $9.479bn a year ago. But look at the balance of payments: we booked a deficit of $5.27bn against a surplus of $1.06bn. Calm prevails only on the surface: deep down, it is turbulent.

Stocks of the government’s overall domestic debt and liabilities went up by only Rs936bn in July-December to Rs22.19 trillion. This pace of increase is slower than what we had seen a year ago — addition of Rs1.03tr. But just look at the total outstanding debt parked in long-term PIBs: it grew to Rs12.17tr in December 2019 from Rs10.93tr — an accumulation of Rs1.24tr within six months. This was entirely different in the past. The stock of debt acquired through PIBs had decreased to Rs3.1tr in December 2018 from Rs3.41tr in June 2018.

The shifting of domestic debt from short-term instruments like treasury bills to long-term PIBs will have serious consequences for debt management in coming years. It will help the government retain domestic debt for a longer period, more so if yields on PIBs do not fall — and competing long-term instruments of non-bank savings certificates do not offer higher rates. Besides, by the end of this fiscal year — and maybe in the year after — the net requirement of the government to retire domestic debt would remain manageable depending on how much of the previously sold PIBs mature and are not rolled over.

This brings the fiscal deficit into discussion. The reason why the government is desperate to keep the net requirement of retiring domestic debt low is obvious: it wants to keep the fiscal deficit in check in the second year of Imran Khan’s premiership. A very high fiscal deficit of 8.9pc of GDP in the PTI’s first year in power (2018-19) was a different thing. But letting the deficit reach closer to that level in the second year (2019-20) might deplete its political capital. In July-December, the fiscal deficit remained 2.3pc of GDP. But it is set to shoot up in the second half because (1) tax revenues are not growing as fast as desired (2) the cost of debt servicing still remains high despite the shifting of the debt stock from short term to long term (3) defence expenses are up owing to increased hostilities of India towards us and (4) prospects of non-tax revenue growing as rapidly as in the first half are not that bright.

During the first half, non-tax revenue shot up to Rs766.7bn from Rs244.6bn in the same period a year ago chiefly because the profits earned by the State Bank of Pakistan (SBP) surged to Rs426.2bn from Rs63.2bn. Such a huge increase is least possible in the second half as profit-yielding operations of the SBP of equal proportions are not in sight.

For a government struggling in domestic debt management and fiscal deficit areas, reliance on the central bank for generating dramatically high non-tax revenue makes little sense. It may upset the ideal equation between fiscal and monetary independence.

The SBP is maintaining its key policy rate at a high level of 13.25pc — and banks’ interest rates for customers remain higher — for a variety of reasons, but much to the chagrin of the industry and agriculture. The monetary policy remains tight partly because fiscal slippages continue and further larger slippages are expected. Maintaining a more prudent domestic debt management policy and improving quality in the external sector gains is necessary.

Published in Dawn, The Business and Finance Weekly, February 24th, 2020