Govt pins public debt ballooning on high interest rate

ISLAMABAD: The Ministry of Finance has come forward to explain reasons behind rising public debt in the last three years and explained that hike in interest rate led to a sharp rise in debt servicing that consumed Rs7.5 trillion, it is learnt.

The depreciation of exchange rate, financing of primary deficit and cash management plan also hiked public debt.

It is relevant to mention here that Pakistan’s total public debt and liabilities ballooned to Rs47.8 trillion till June 30, 2021 against Rs29.6 trillion by end of June 2017-18 when the PML (N) led government had completed its five-year rule.

The public debt and liabilities stood at Rs6 trillion by the end of Musharraf rule in 2007-08. Then the PPP ruled over next five years and they went up to Rs14 trillion. Then total public debt surged by Rs14.6 trillion and increased up to Rs29.6 trillion by the end of PML (N) rule in 2017-18.

During the last three-year rule of the PTI-led government, the total public debt and liabilities swelled by Rs17.8 trillion at least so they made a record for the highest ever increase in debt burden in a three-year period.

However, the Ministry of Finance in its statement stated this was in response to some media reports regarding increase in public debt during the last three years while these media reports ignored the underlying reasons behind such increase.

Therefore, in order to fully understand the underlying economic realities, there is a need to analyse the sources of increase in total public debt during last three years:

Preference towards short-term domestic borrowing in absence of adequate cash buffers resulted in short-term profile of domestic debt at the end of FY2018. This short-term profile led to high interest cost on debt as interest rates had to be increased significantly to curb rising inflationary pressures. The government paid Rs 7.5 trillion against interest servicing which explained 50 percent of the increase in total public debt.

Exchange value of the rupee was maintained at an artificially high level in the past, which triggered the balance of payment crisis. Transition to market-based exchange rate regime, being an unavoidable policy choice, resulted in sharp exchange rate depreciation leading to high inflation, high interest rates, slower GDP growth and lower import-related tax revenues. This exchange rate depreciation added around Rs2.9 trillion (20 percent of the increase) in public debt. It is important to highlight here that this increase was not due to borrowing but due to revaluation of external debt in terms of rupees after currency devaluation.

The impact of economic slowdown due to the Covid-19 pandemic mainly resulted in higher than estimated primary deficits and about Rs3.5 trillion (23 percent of the increase) was borrowed for financing primary deficit. As much as Rs1.0 trillion (7 percent of the increase) was on account of increased cash balances of the government to meet emergency requirements as well as due to difference between the face value (which is used for recording of debt) and the realised value (which is recorded as budgetary receipt) of government bonds issued during this period. Government took the revolutionary and economically sound step of not borrowing from the SBP and maintaining a cash buffer, which led to a one-off increase in debt. However, this increase in debt was offset by corresponding increase in the Government’s liquid cash balances.

A better way to measure level of debt is through Debt-to-GDP ratio instead of looking at the absolute values of debt. In this light, it is important to highlight that Pakistan has witnessed one of the smallest increases in its Debt-to-GDP ratio during pandemic. Global Debt-to-GDP ratio increased by 13 percentage points, whereas, Pakistan’s Debt-to-GDP ratio witnessed minimal increase of 1.7 percentage points in 2019-20.

Pakistan’s Debt-to-GDP ratio in fact reduced by 4 percentage points indicating lower debt burden at end June 2021 as compared with last fiscal year.

To conclude, the increase in debt during last three years occurred mainly during FY 2018-19 due to implementing difficult and unavoidable policy choices. Had the market-based exchange rate, a sustainable level of Current Account Deficit, adequate cash buffers and long-term domestic borrowing profile been maintained, the debt burden would have been reduced further on the back of fiscal consolidation efforts supported by aggressive control on expenses and growth in tax and non-tax revenues.

As most of the major adjustments to fiscal and monetary policies have been made, debt burden is projected to decline firmly over the next few years, the statement concluded.