Public debt: boon or bane? - Part I

August 28,2018

Few subjects have received as much attention in recent years as the subject of public debt did – that too mostly negative. The subject has been so maligned that ordinary people believe it is...

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Few subjects have received as much attention in recent years as the subject of public debt did – that too mostly negative. The subject has been so maligned that ordinary people believe it is fundamentally bad and that, in the recent past, governments have accumulated debts that are beyond the capacity of the country to repay.

Some will even venture into speculations that our sovereignty has been affected and we will soon have to pay a price that will compromise our national security.

In his first speech to the nation, the prime minister added his voice to such concerns. While we applaud the spirit and motivation underlying his aversion towards indebtedness, there are a few conceptual issues that need to be clarified. We do so to allow a correct assessment of the debt problem.

First, there is a difference between personal debt and public debt. An individual has a limited capacity to borrow; he will be distressed if he is unable to discharge debt when due. Refinancing loans by taking more loans is out of the question for individuals except when it comes to Ponzi schemes run by conmen.

The public debt is entirely different. It has two components – domestic and foreign. The former is denominated in local currency, while the latter in foreign currency. The local currency debt, in principle, can be paid at any time since the government has the authority to print currency. Only in the context of foreign debt does one face problems. As we argue below, for faster development, there is no escape from taking foreign loans in measured quantities.

Second, the debt burden is assessed relative to the borrower’s capacity to repay. A poor man will feel burdened with debts of a few hundred rupees, but for someone well-off, this will not be a burden. For public debt, the ratio of debt-to-GDP is an indicator of debt burden. It is misleading to compare nominal debt and use it to signify the increase in debt burden.

For instance, in 2007-08 (the year the prime minister often cites in his speeches) the public debt was Rs6 trillion – 57.6 percent of GDP. Compared to that, in 1998-99, debt was only Rs2.9 trillion, but was 100.3 percent of GDP. Now consider the nominal debt for 2017-18, projected at Rs25.2 trillion. Nominal comparison would indicate the debt has increased from Rs6 trillion to Rs25.2 trillion, more than a four-fold increase. But based on a comparison of debt ratios, the increase is only from 57.6 percent to 73 percent, or an increase of 15.4 percentage points. The previous government had inherited a ratio of 63 percent in 2012-13. Thus, during its tenure the increase is nine percentage points.

The limit specified in the fiscal responsibility law requires the ratio to be 60 percent or less. In fact, in 2016, the law was amended and now requires reducing the ratio further to 50 percent in the next 15 years, until 2033-34. The current ratio is indeed high and reducing it should be a priority. However, no sky is falling upon us. International comparison indicates that the debt ratios for Egypt (104), Greece (180), Italy (104), Japan (236), Portugal (126), Spain (98), Singapore (111), UK (87) and the US (108) are significantly higher than that of Pakistan. India has a ratio of 70 percent.

Third, what is perhaps more significant is the share of foreign debt in public debt. About $75 billion of foreign debt has a share of 33 percent in the total debt. Measured in terms of GDP, external debt is around 23 percent – quite modest by international standards. Even within external debt, 85 percent is owed to bilateral (Paris Club and China) and multilateral (IMF, WB, ADB and IDB) lenders, carrying concessional terms. Only 15 percent is owed to international capital market (bonds and Sukuk) or commercial banks.

Fourth, the prime minister has justifiably lamented that borrowings are done even to pay for interest payments. This is a state of primary deficit, a condition that points to an explosive build-up of debt. However, such episodes have occurred in the past, and can be corrected quickly with prudent fiscal management.

Fifth, the use of debt has permeated our economic management. With low tax and revenue effort (less than 15 percent of GDP) and expenditures of close to 22 percent of GDP, we have a very large dependence on borrowings to run the affairs of the country. Governments in the past have shown weak commitment to fiscal discipline. The key to this is to close the fiscal deficit, both through an increase in tax effort as well as by containing expenditures. This is a tall order but achieving it is possible.

Sixth, foreign debt is essential for several reasons. Domestic resources are limited compared to the investment needs of the economy to maintain a growth rate that produces enough jobs to absorb the new entrants in the labour market. This extra need is met through foreign savings which come in the form of current account deficit. However, in the last two years this deficit had shot up to an unsustainable level, as we could not finance it from foreign investment and external borrowings. We consequently had to draw down on our precious foreign exchange reserves, which have now fallen to a dangerous level of less than eight weeks of imports.

In fact, we also need borrowings to build reserves. In the process, more room is created for credit to the private sector since domestic borrowings are reduced by the same amount. Higher reserves signal stability and raise the confidence of foreign investors. The cost of foreign debt is much lower than domestic cost, but we run the risk of currency depreciation that eventually raises the cost. The solution for this lies in maintaining exchange rate stability and not abandoning foreign borrowings.

Next, we will focus on where the monies mobilised through debt are used, and what is needed to limit future growth in debt within sustainable limits.

To be continued

The writer is a former finance secretary. Email:


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