No default risk on govt debt

Our total external debt and liabilities have grown from $64 billion in September 2014 to $66.4 billion as of September 2015; a year-over-year increase of 4 percent. Our external debt has grown from Rs5.7 trillion in 2013 to Rs6.5 trillion (as of the first quarter of fiscal year 2016); an increase of 13.5 percent over the three-year period.

Our external debt profile is such that close to 90 percent of the debt is multilateral, concessional (read: debt with below market rates), soft and long term (20 years or more plus grace periods). Of the total external debt around 10 percent is in the form of Euro bonds, NHA bonds etc with market rates (read: debt with high interest rates). Consequently, all we need is about a billion dollars to service our foreign debt. And with net SBP foreign exchange reserves of $15.3 billion (as of February 5) the default risk in the next few quarters is near-zero.

The government’s domestic debt, on the other hand, has grown from Rs9.5 trillion in 2013 to Rs12.7 trillion as of the first quarter of fiscal 2016; a rather alarming increase of more than 33 percent. The government’s domestic debt comprises permanent debt, floating debt and unfunded debt. The government’s permanent debt represents government borrowing through instruments that are greater than one year maturity while the government’s floating debt is short term, up to one year. And unfunded debt comprises National Savings Schemes (NSS) and prize bonds that are encashable on demand.

Currently, our commercial banks are the biggest source of funding for the government (both permanent and floating debt). The government sells more than a trillion rupees worth of Treasury Bills of three, six and twelve month maturities every quarter-and the banks buy more than a trillion rupees worth of Treasury Bills of three, six and twelve month maturities every quarter.

The government uses 95 percent of the funds raised to pay off prior debt maturing during the period and the remaining 5 percent is used by the government to meet its current needs. And the default risk on the government’s domestic debt in the next few quarters is near-zero-the reason being that the banks will continue to refinance the maturing government debt because of lack of alternative, more attractive investment opportunities.

The one risk that Pakistan’s commercial banking system now faces is concentration risk which simply means that commercial banks have lent out an alarmingly high percentage of their accounts to the government. The one risk that the government now faces is refinancing risk which simply means the possibility that the government in the not too distant future may not be able to refinance by borrowing in order to pay off existing debt.

The bottom line is that there is little or no default risk in the immediate future but also that the government’s refinancing risk is taking quantum jumps heading in the direction of a dangerous debt trap.