PAKISTAN is in the vice of a debt ‘trap’. Nothing reveals this more starkly than the recently released figures for the fiscal deficit and total debt and liabilities for 2018-19. The budget deficit has been recorded at 8.9 per cent of GDP, while total debt and liabilities have increased by a hefty Rs 10.3 trillion, or 35pc, in the last fiscal year alone, to cross Rs 40tr. At this level, the country’s total debt and liabilities stand at 104pc of GDP, with gross public debt at 85pc of GDP, well above the threshold stipulated under the country’s fiscal responsibility and debt limitation act of 2005.
The headline numbers have been widely used as a whipping instrument against the government, with the media and commentators generally attributing the fiscal ‘blowout’ entirely to the PTI government, accusing it of gross fiscal indiscipline in the last one year. Surprisingly, even more serious commentators have conducted a superficial analysis and declared the dire fiscal situation a ‘disaster’ entirely of the government’s making. However, a sober and objective examination reveals the role of four major factors behind the deterioration of public finances in the past one year.
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Consider the 35pc increase in the country’s total debt and liabilities during 2018-19. This figure is recorded in rupees, but includes a sizeable portion of external debt and foreign exchange liabilities denominated mainly in US dollars that is converted at the year-end exchange rate. The Rs/$ rate used for this conversion of the outstanding external debt stock into rupees stood at 121/$ on June 30, 2018 — but had fallen to Rs 163/$ on June 30, 2019, thus adding Rs4.3tr just on account of the depreciation of the exchange rate. This represents 41pc of the total increase recorded in the country’s debt and liabilities for 2018-19.
By my estimation, another roughly Rs 500 billion is accounted for by higher interest payments incurred by the government due to the IMF-mandated 6.75 percentage point increase in the policy rate. An additional Rs667bn is on account of the over $4bn increase in external debt servicing during 2018-19 related to past borrowing by the PML-N government that became due during the year. The government had to resort to additional borrowing to meet these expenditures, thus increasing public debt.
The parlous state of public finances presents a dire challenge.
Finally, the government undertook nearly Rs1.2tr of ‘pre-emptive’ borrowing from the State Bank of Pakistan before the close of the year, and before the start of the IMF programme, and placed it in its cash reserves to retire some lumpy domestic debt repayments coming due this fiscal year.
Combined, these four factors alone account for 70pc of the increase in total debt and liabilities recorded during 2018-19.
A similar, largely unreported, story pertains to the budget deficit, which widened from 6.6pc cent in 2017-18 to 8.9pc of GDP in 2018-19. While the tax revenue shortfall has generally been held responsible in the media for the expanding fiscal deficit, it has played a minor role compared to two other, more significant, factors. Interest payments on public debt were higher by Rs591bn in 2018-19 compared to 2017-18. Non-tax revenue, of which SBP profits transferred to the budget are a substantial component, recorded a fall of Rs334bn. These two factors together explain 80pc of the increase in the fiscal deficit — but have been largely ignored by the media and the commentariat. A lower provincial surplus reflected in the consolidated budget explains much of the rest of the difference.
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With interest payments now the largest component of budgetary expenditure by far, accounting for 30pc of total current expenditure, it is difficult to see where expenditure cuts can be applied in the immediate term. Two ways of looking at the elephant in the room are as follows: a) while the ‘headline’ fiscal deficit is 8.9pc of GDP, adjusted for interest payments (which have to be made and are non-discretionary), the budget deficit is 3.5pc. The latter is referred to as the primary deficit. b) Interest payments now account for 103pc of net federal revenue, after the constitutionally mandated transfers to provinces.
Given this fiscal straitjacket, the primary deficit, rather than the headline budget deficit, along with the tax revenue, is the main object of focus in the current IMF programme.
While the focus on tax revenue from a broader segment of the tax-eligible population has strong underpinnings and rationale, despite a misplaced challenge from libertarian quarters (which will be addressed in a subsequent article), the IMF’s ideological and un-nuanced fight against all manners of expenditure without discriminating between those that feed into aggregate demand and those that do not, needs greater scrutiny. Cutting energy subsidies for vulnerable segments of the population, or subsidies for the export sector, for example, may be quick ‘fixes’ for a bloated budget but do not appear to be the right one.
In any case, given the budget constraints imposed by low-revenue collection, Pakistan has been practising ‘austerity’ for far too long. The development budget has fallen from over 7pc of GDP in the 1980s to a mere 2.6pc currently. Non-interest expenditure is 16.2pc of GDP, whereas it should be closer to 20pc (even after making allowance for greater efficiencies in spending) to accommodate higher spending on education, health, infrastructure, maintenance, public service delivery and other critical expenditures such as building resilience to climate change or enhancing the FBR’s capacity.
Savings on the expenditure side need to come from structural measures — such as curtailing the losses of public-sector enterprises, reducing leakages in public-sector development projects and procurement, improving the efficiency of the power sector and making savings through more effective public debt management etc. Materialising these will take a few years of serious reform effort.
Till such time, the painful fiscal squeeze is likely to continue with its effects felt broadly.
The writer is a former member of the prime minister’s economic advisory council, and heads a macro-economic consultancy based in Islamabad.
Published in Dawn, September 13th, 2019