pakistan public debt

8/8/2019 Pakistan Public Debt

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Emma Xiaoqin Fan

Pakistans Public Debt

April 2007

A BRIEF OVERVIEW

PRM Policy NoteSeries No. 1Pakistan Resident Mission


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Pakistan Resident MissionAsian Development Bank1st Floor OPF Building

Sharah-i-Jamhuriyat, G 5/2Islamabad. Pakistan 2007.

PRM Policy Note Series Review Committee

Chair:

Peter Fedon, Country Director, Pakistan Resident Mission,

Asian Development Bank

Members:

Emma Xiaoqin Fan, Senior Public Resource Management SpecialistSafdar Parvez, Programs Officer

Farzana Noshab, Economic Policy Officer

Waqas ul Hasan, Project Officer, Governance

The PRM Policy Note Series is based on papers or notes prepared byPRM staff and resource persons. The series is designed to provideconcise nontechnical accounts of policy issues of topical interest.Though prepared primarily for internal readership within the ADB, theseries may be accessed by interested external readers. Feedback iswelcome via e-mail ([email protected]). The views expressed here are

those of the authors and do not necessarily reflect the views or policiesof ADB.

PRM welcomes submission of brief papers from both ADB staff andexternal contributors which are of policy relevance and of importance toPakistan for the PRM Policy Note Series. The papers can be submitted toMr. Khurram Imtiaz Butt ([email protected]).


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Emma Xiaoqin Fan is a Senior Public Resource Management Specialist in the PakistanResident Mission of the Asian Development Bank. The author thanks Peter L. Fedonand Safdar Parvez for the comments and suggestions they provided when reviewing anearlier draft.

Emma Xiaoqin Fan

Pakistan Public Debt

April 2007

A BRIEF OVERVIEW

PRM Policy NoteSeries No. 1Pakistan Resident Mission


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Pakistan's Public DebtA brief overview

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1. Introduction

Public debt is an important means of bridging government

financing gaps. Effective and efficient utilization of public debt

can increase economic growth and help a government to

achieve its development and social objectives. However,

public debt is also a doubled-edged sword. Excessive reliance

on public debt and inappropriate public debt management

raise macroeconomic risks, impede economic growth, and

hinder economic development. For example, high public debt

demand can increase the domestic interest rate thereby

crowding out private investment. An escalating external public

debt stock increases the probability of default, raising theinterest risk premium charged by creditors. High interest

payments further enlarge a country's public debt obligations,

accelerate budget outlays, and squeeze capital investment

and social expenditure. In extreme cases, governments can be

forced into defaulting on public debt, which tarnishes a

country's international reputation and makes further borrowing

difficult, whereas monetization of public debt generates highinflation. Both of these actions are likely to precipitate capital

flight and spark financial crisis.


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This note briefly examines the public debt situation in Pakistan.

The objective is to understand the assistance from multilateral

sources, especially from the Asian Development Bank (ADB),in a broader context. The note pays particular attention to

external public debt in the country.

2. Public debt some conceptual considerations

Public debt can be examined from the sources, the uses, and

debt management perspectives.

In debt financing, government can borrow from a number ofsources, including the central bank, domestic commercial

banks, domestic non-bank sectors, and external sources.

Government usually utilizes a number of options at the same

time. Public debt raised through different sources has different

macroeconomic implications. Borrowing directly from central

banks is equivalent to printing money. It increases the high

power money which in turn translates into monetaryexpansion. This approach is thus highly inflationary and

generally discouraged. Borrowing from domestic commercial

banks is less inflationary, although it may crowd out private

investment. Government borrowing from the non-bank private

sector has no effect on the money supply and hence no

implications for interest rates and inflation from the supply

side. However, the debt held by people can exert an upwardpressure on interest rates from the demand side. Borrowing

from abroad has become a major feature of developing

countries. Foreign borrowing allows a country to invest and

consume beyond the limit of current domestic production, and

can be conducive to economic growth. However, excessive

reliance on foreign borrowing exposes a country to numerous

risks (Hanif 2002).The use of public debt also has economic implications.

Generally speaking, financing capital and development

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related projects can help a country to build its production

capacity and facilitate economic growth. In particular,

borrowing from external sources enables a country to financecapital formation not only by mobilizing domestic savings but

also by tapping into foreign capital surplus. Foreign borrowing

can thus lead to more rapid growth. For example, Siddiqui and

Malik (2002) found that foreign borrowing increased resource

availability and contributed to economic growth in South Asia.

However, excessive foreign borrowing and its improper use

generate severe debt service obligations and can constraineconomic policies and growth.

A country's debt management program needs to take into

consideration both the source and use of loans so as to raise

and utilize the debt in ways that benefit a country's long-term

development. Debt management is the process by which the

government aims to acquire and utilize the debt efficiently and

effectively. Debt management strategies not only need toexplore new and cheap sources of finance, but also to

consider the proper use of borrowed funds. The technical

aspects of debt management focus on the need to determine

the level of financing requirements and to ensure that the terms

and conditions placed on borrowers are commensurate with

their future debt servicing capacity. The institutional aspects of

debt management deal with organizational, legislative,accounting, and monitoring aspects of new borrowing as well

as the total stock of debt. The availability of funds and the

market conditions are important for the choice and design of

borrowing instruments (Hanif 2002).

A key to external debt management is debt sustainability. This

term refers to the level and combination of debt which allows a

country to meet its current and future debt service obligationsin full, without recourse to debt relief and rescheduling, and

avoiding accumulation of arrears. Sustainability of debt is a

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situation where the debt-to-income ratio declines, or at least,

remains constant over years. A general consideration is that for

the debt ratio to remain unchanged, the budget deficit doesnot have to be zero, but it must not push the debt to increase

faster than GDP. Thus, the conventional wisdom does not

consider public debt per se as a major problem. Rather, the

core problems are the mismanagement and/or unsustainable

nature of public debt (Hanif 2002).

There are various indicators for determining a sustainable level

of external debt. Broadly, there are two types of debt indicatorsthat assess the country's debt sustainability position: solvency

and liquidity indicators. The solvency indicators include ratios

such as debt to GDP, debt to foreign exchange earnings, debt

servicing to foreign exchange earnings, and the public debt

service to current fiscal revenue ratio. These measures reflect

the country's ability to service its external obligation on a

continuing basis. The liquidity indicators include ratios such asreserves to short-term debt and reserves to total debt. They

reflect a country's liquid assets that affect the ability to service

its immediate external liabilities.

3. Public Debt in Pakistan

stPakistan entered the 21 Century with serious financial

problems. Public debt exceeded 90% of its GDP, over 600% ofits annual revenues, and debt servicing accounted for over half

of current revenues. In 2001, Pakistan was the only country in

South Asia to be classified as a severely indebted country by

the World Bank. Due to the inability to service external debt,

there were two consecutive rounds of debt rescheduling by

Paris Club members and one from the quasi-London Club

between 1998 and 2001. Pakistan had to seek exceptionalfinancing arrangements from the International Monetary Fund

in January 1999, after facing a severe balance of payments'

crisis. This outcome was the result of persistent and rising

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fiscal deficits, stagnant export receipts, declining worker

remittances, and large current account deficits.

The Pakistan economy has experienced a turnaround since2000. Growth has accelerated, and most macroeconomic

indicators have improved. Public debt indicators have also

shown significant improvement. Modest growth in public debt,

coupled with the strong growth in nominal GDP, led to a

significant fall in public debt to GDP ratio, from 81.4% in

2001/02 to 56.1% in FY 2006 (Table 1). Over the same period,

domestic public debt to GDP ratio fell from 40.4% to 29.9%,while the external public debt to GDP ratio fell from 41.0% to

26.2%. In fact, FY2005/06 is the fifth successive year that the

public debt to GDP ratio has improved. This is also the first time

in more than two decades that the ratio has fallen below 60%.

The Fiscal Responsibility and Debt Limitation Act, 2005

envisaged a debt to GDP ratio of 60% by FY13. The actual

achievement has thus exceeded the target in the Act (IMF2006).

The improvement in the public debt to GDP ratio in FY06 was

due to the fact that both domestic and external debt grew

slower than GDP. The growth in domestic debt has been

slightly faster than that of external debt. It rose by about 5.9%

while external public debt grew by about 5.0% relative to the

previous year. Total public debt stock stood at around $72

billion, about 5.5%, higher than the previous year, of which

domestic public debt consists of about $38 billion. As a result

of a stronger rise in domestic debt, the share of external public

debt in total public debt decreased from 50.4% in FY2002/03 to

46.7% in 2005/06.

The debt servicing capacity of Pakistan has also improved overthe past few years. As growth in foreign exchange earnings in

Pakistan outpaced the growth in debt servicing payments,

external public debt servicing as a share of exports of goods

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and non-factor services declined from 35.8% in 2001/02 to

14.1% in 2005/06. The external debt service to gross reserves

ratio has declined from about 70% in 2001/02 to over 20% in2005/06. International reserves act as a cushion against

fluctuations in foreign exchange earnings.

Pakistan's external debt is predominately long and medium

term debt. Over 99% of public and publicly guaranteed debt is

over one year. Pakistan acquired about US$ 3.3 billion long-

term loans in FY 2005/06, of which about US$ 1.7 billion

reflects the long-term flows from ADB and the World Bank.While approximately US$ 1.7 billion in loans were committed

by international donors for the earthquake fund in 2006, the

actual disbursement was limited to US$ 768 million, of which

US$673 million of the disbursement came from the ADB and

World Bank. The remaining multilateral loans disbursed in

FY06 were mainly to support poverty reduction and economic

reforms.

The ADB disbursements in FY06 included US$60 million and

US70 million for social services programs to the Punjab and

Sindh Governments respectively to improve the quality of

human capital, specifically in education and health. Another

ADB loan of US$80 million was disbursed under the financial

markets and governance program. Punjab received US$ 199

million from the World Bank for education sector reform. The

World Bank also disbursed a loan of US$ 102 million for Punjab

irrigation/policy-II and US$ 69.5 million for NWFP (SBP 2005).

Clearly, the loans from the ADB and the World Bank play an

important role in the government's external debt financing. The

relatively high share of the multilateral loans calls for sound

program/project design and implementation in order to yieldthe maximum benefits to the country. Indeed, the multilateral

development banks are the largest creditors for Pakistan's

external public debt, totaling about 51% of total public external

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debt in FY2005/06. This is followed by the Paris club which

accounts for about 39%. In recent years, the outstanding stock

of Paris club debt declined, partly due to debt write off. Debtfrom other sources has been relatively small. Despite this,

activities from bi-lateral agencies have also increased.

Pakistan also accessed the international capital market to raise

funds through the issuance of Euro Bonds in FY 2006. This

raised US$ 800 million which consists of 10-year bonds of US$

500 million and US$ 300 million in 30-year bonds. The

issuance of the Euro bond not only addresses thegovernment's finance needs, but also helps to establish a

long-term sovereign benchmark that would help local

corporate enterprises access global markets.

4. Factors underlining the improved debt indicators

in Pakistan and issues

The improvement in the debt indicators reflect acceleration ineconomic growth, improvement in fiscal conditions, increases

in export earnings, and higher capital inflows. In particular,

external conditions have become more favorable to Pakistan

since September 2001. This has enabled relief of public debt

amounting to about $3.7 billion between 2001 and 2003.

Coupled with debt rescheduling, this has significantly reduced

Pakistan's debt servicing burden. There have been increasedofficial transfers, especially between 2001 and 2004. Total

official transfers amounted to about $4.5 billion from 2001 to

2006. Workers' remittances have also increased significantly,

averaging around $4 billion a year during 2003-2006

compared to about $1.5 billion in the 1990s. These factors

have reduced the need for external borrowing.

There has been a particularly noticeable increase in foreigndirect investment (FDI) in Pakistan in recent years, reflecting

the country's privatization programs and increased investor

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confidence. FDI rose from $483 million in FY2002 to $3.5 billion

in FY2006. The first half of FY2007 saw a further 64.6% increase

to $1.9 billion. The sale of the Karachi Electric Supply Companyand the partial sale and transfer of management control of

Pakistan Telecommunication Company Limited revitalized the

privatization process in 2006. FDI inflows, excluding

privatization, also rose by 70% in 2006. Strong foreign demand

for Pakistani assets (including from oil-exporting countries in

the Gulf region) was also reflected in the favorable terms for

new bond placements in international capital markets. The FDIand other capital inflow have more than offset the current

account deficit, and resulted in payments surplus of over US$1

billion in 2006.

While Pakistan has significantly improved its economic

performance and the debt situation, strong efforts must be

made to guard against potential risks. First, the improved debt

indicators in Pakistan are closely linked with favorable externalconditions. To sustain sound economic performance over the

long term, Pakistan must maintain political and economic

stability. Economic reforms must go on apace to sustain and

improve domestic and foreign investors' confidence. A sound

policy environment that attracts sustained FDI inflow is

particularly important given that FDI involves long term

financing and is not susceptible to sudden withdrawals.Creating a conducive policy environment for increased

domestic investment is also a key.

Second, coupled with strong capital inflow, the current account

deficit has increased since 2005. In FY2006, the current

account deficit, excluding official transfers, more than tripled to

$5.7 billion, or 4.4% of GDP as import growth outstripped

export growth because of higher oil prices and strongdomestic demand. Privatization proceeds, official grants, and

portfolio investment together financed 45.3% of the current

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account deficit. The rising current account deficit per se is not

necessarily a problem. For example, strong domestic capital

formation can lead to increased demand for capital goodsfinanced by capital inflow. Singapore had run current account

deficit for more than 10 years during its rapid industrialization

period. To a certain degree, a current account deficit and

balance of payments surplus indicate the strengths of the

domestic economy and the confidence of foreign investors in

the domestic economy. However, increased current account

deficits raise concerns about the sustainability of financinglarge deficits in the medium and long term if the capital inflow is

not significantly contributing to the increased productive

capacity and efficiency of a country.

Third, the large inflow of official assistance and workers'

remittance also poses the risks of Dutch Disease in that high

capital inflow can lead to real exchange appreciation,

rendering domestic tradable sectors, especially themanufacturing sectors, less competitive. The utilization of

foreign aid thus must be geared towards spending on

increased productivity and to provide a conducive

environment for private sector development while avoiding the

fostering of a bloated public sector.

5. Conclusions

This note briefly reviewed public debt information for Pakistan.

It reveals a number of important features.

First, the public debt situation is closely related to broader

economic performance. Accelerating economic growth,

improving fiscal conditions, increasing export earnings, and

increased foreign direct investment have provided the

foundation for improved debt management in Pakistan.

Second, the improved debt situation is also attributable to

more favorable external conditions for Pakistan since

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September 2001. This has led to debt relief and rescheduling,

and increased official inflow and workers remittances. While it

has helped the country to achieve a significant improvement indebt indictors in the short run, it also exposes Pakistan to risks

relating to the sustainability of both economic performance

and debt management.

Third, in order to sustain and build on its existing

achievements, Pakistan needs to deepen its structural reforms

to improve the domestic investment environment, external

competitiveness, sustain macroeconomic stability, andmaintain political stability. Reforms that improve a country's

creditworthiness and investment climate are important for

improving domestic savings and investment, attracting FDI,

and diversifying the financing sources. FDI is especially

important because it not only brings in finance, but also

contributes to technology transfer and improved management

know-how. Pakistan has had considerable success inattracting FDI in FY06. However, much can be done to improve

on this performance in the years ahead.

Fourth, sound public debt management supports

macroeconomic stability and economic growth. Debt

management should take advantage of favorable economic

conditions to strengthen the technical and institutional

capacity in managing public debt.

Fifth, multilateral development banks play an important role in

lending to the Government. This calls for sound project and

program designs and implementation to enhance the

effectiveness of development assistance. Introducing

innovative and efficient assistance approaches and practices

in response to the changing context of economic developmentis especially important.

The recent economic development and developments in

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13

external debt show that Pakistan is at a cross road. The strong

economic performance, including the improvement of the

public debt situation over the past few years, if sustained, canput Pakistan on a sustained growth path. But there are real

challenges and risks that need to be managed carefully.

Maintaining political stability, sound macroeconomic

management, and structural reforms are key for Pakistan to

move forward.

Table 1. Public debt indicators in Pakistan

17.30

209.50

298.09

16.10

183.70

328.30

14.10

168.30

314.11

5. External debt service (%)

external public debt serviceas % of exports of goodsand nonfactor services

external public debt as % ofexports of goods andnonfactor services

external public and publiclyguaranteeddebt as % ofgross reserves

35.80

282.00

679.71

26.60

229.00

312.06

1. Debt stocks (US$ million)

Total Government debt

Public debt: domestic

Public debt: External

2. Debt as a % of GDP (%)

Total government debt

Domestic public debt

External public debt

3. Annual average growth

rate of debt (%)

Growth: total public debt

Growth: domestic public debt

Growth: external public debt

4. External public debt as % of

total publicdebt

FY2001/02

FY2002/03

FY2003/04

66511.80

35021.70

31490.10

67.80

35.70

32.10

6.94

7.89

5.90

47.35

FY2004/05

68598.00

36408.00

32190.00

61.80

32.80

29.00

3.14

3.96

2.22

46.93

FY2005/06 (est)

72369.00

38571.00

33798.00

56.10

29.90

26.20

5.50

5.94

5.00

46.70

58526.60

29047.60

29479.00

81.40

40.40

41.00

50.37

62197.80

32461.80

29736.00

75.30

39.30

36.00

6.27

11.75

0.87

47.81

Source: International Monetary Fund, Pakistan: 2006 Article IV Consultation Staff Report


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Table 2. External Debt Stock ($ million)

ITEM

1.Public and Publically-Guaranteed debt

A. Medium and long term(>1 year)

Paris club

Multilateral

Other bilateral

Euro bonds/Saindak Bonds

Military debt

Commercial Loans/credits

B Short Term(1 yr)

3.IMF

Total External Debt (1 through 3)

4.Foreign Exchange Liabilities*

Foreign Currency Accounts

29235

29052

12516

14331

429

643

819

314

183

183

2226

1939

33400

3132

406

30/06/02

29232

29045

12607

14950

512

482

263

231

187

187

2028

2092

33352

2122

0

30/06/03

29875

29853

13558

14349

720

824

204

198

22

22

1670

1762

33307

1951

0

30/06/04

31084

30813

13014

15358

805

1266

188

182

271

271

1342

1611

34037

1797

0

30/06/05

32603

32407

12831

16527

847

1908

130

165

196

196

1585

1491

35679

1586

0

**

30/06/06

**

30/09/06

33153

32897

12818

16989

929

1906

90

165

256

256

1565

1478

36196

1528

0

FE - 45

FE-13/For 01:FE25CRR w/SBP

FE - 31 deposits (incremental)

Special U.S $ Bonds

Foreign Currency Bonds (NHA/NC)

National Debt Retirement Program

Central Bank Deposits

NBP/BOC Deposits

Other Liabilities (SWAP)

FEBCs/FCBCs/DBCs*

Total External Liabilities (1 through 4)*

Official Liquid Reserves

* Excluding FEBCs/FCBCs & DBCs from 30/06/99_ 1/ Resheduled Private Debt included by GOP so excluded from the stock of Private debt**Provisional

30/06/02234

0

172

924

197

75

750

500

280

66

36532

4337

30/06/030

0

0

696

175

6

700

500

45

42

35474

9529

30/06/040

0

0

552

153

1

700

500

45

22

35258

10564

30/06/050

0

0

421

131

0

700

500

45

10

35834

9805

**30/06/060

0

0

247

109

0

700

500

30

7

37265

10765

**30/09/060

0

0

211

87

0

700

500

30

6

37724

10,187

Source: State Bank of Pakistan, http:/www.sbp.org.pk/


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References

Hanif, Muhammad Nadeem, The Journal, National Institutionof Public Administration, Karachi, Pakistan Vol. 7, No. 4, PublicDebt Management, pp. 41-72, Dec. 2002.

International Monetary Fund (IMF), Pakistan: 2006 Article IVConsultation-Staff Report: Public Information Notice on theExecutive Board Discussion; and Statement by the ExecutiveDirector for Pakistan, Washington DC, 2006.

Siddiqui, Rehana and Malik A. Debt and economic growth inSouth Asia, Paper presented in the 17th Annual GeneralMeeting of PSED, Islamabad, January 2002.

State Bank of Pakistan (SBP), Annual Report 2005-06.


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About the Asian Development Bank

ADB is dedicated to reducing poverty in the Asia and Pacific regionthrough pro-poor sustainable economic growth, social development,and good governance. Established in 1966, it is owned by 67members - 48 from the region. With headquarters in Manila, ADB has26 offices around the world and more than 2,000 staff from over 50countries. In 2006, it approved loans and grants for projects totalingUS$8.5 billion, and technical assistance amounting to almostUS$242 million.

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