NationalVOLUME 15 ISSUE # 09

Public debt: The changing context

There is much hue and cry over the rising public debt which grew from Rs3.2 trillion in 2000 to Rs32.7 trillion in 2019.

The increase is huge but it has be seen in terms of GDP – which grew from Rs4.2 trillion to Rs38.6 trillion in the same time – almost 10 times. This means that the capacity to absorb debt also increased 10 times. A little bit of history to put things in context. Before 2000, Pakistan was heading towards an external debt trap. The crisis was averted in the Musharraf era as foreign public debt declined from 50.9 percent of GDP in 1999 to 23.4 percent in 2007. The domestic debt also fell from 47.4 percent to 28.3 percent in the same time. Overall public debt fell from 98.3 percent to 51.6 percent.

However, later higher fiscal spending resulted in an increase in debt from 51.6 percent of GDP in 2007 to 70.4 percent in 2018. The foreign debt declined and reached a low of 17.4 percent in 2015 before inching up to 22.7 percent in 2018. It again started increasing in 2015 to finance the growing current account deficit.

The real problem was growing domestic debt which increased from 28.3 percent of GDP in 2007 to 47.8 percent in 2018. Government borrowing from the State Bank of Pakistan (SBP) increased from Rs1.2 trillion (9.1% of GDP) in 2009 to Rs3.6 trillion (10.4% of GDP) in 2018. If we add around Rs2 trillion of commercial banks’ refinancing to the government, the figure rises to Rs5.6 trillion (16.2% of GDP). The number increased to Rs6.7 trillion (17.4% of GDP) in 2019.

A negative result of higher domestic debt reliance on the banking system is that it is crowding out the private credit. It peaked at 27 percent of GDP in 2007, when domestic debt was at its lowest ebb (28.3% of GDP). Thereafter, domestic public debt increased to 47.8 percent of GDP in 2018, and private credit fell to 17 percent of GDP. In other words, lowering domestic public debt can create space for private credit to grow up.

The latest figures show that debt has increased substantially in 2019. Both domestic and foreign public debt increased in terms of GDP – from 47.7 percent to 53.8 percent and 22.6 percent to 28.1 percent, respectively. The reason for this is a rising fiscal deficit of Rs3.44 trillion in 2019 (FY19). The government domestic debt in absolute terms increased by Rs4.3 trillion and, adjusting to additional cash balance of the government with banks, the net increase in debt is Rs3.3 trillion. In case of external public debt, it increased from $75.4 billion to $84.0 billion.

The external debt, net of foreign exchange liabilities, increased by $2.9 billion and converting it into rupees at an average exchange rate of FY19 of 136.4, the number is estimated at Rs392 billion. The total debt, domestic and foreign, adjusting for foreign exchange liabilities and increase in cash balance, is around Rs3.76 trillion versus Rs3.44 trillion of the fiscal deficit.

The sudden rise in debt in FY19 is explained by the fact that the majority of foreign debt is for balance of payment support, and around Rs1.3 trillion of SBP domestic debt taken in Jun-19 has been kept as excess cash to create buffer. That is why the debt numbers are falling from Jun-19 to Sep-19 – from 81.2 percent of GDP to 75.6 percent of GDP (foreign debt- from 28.1% to 24.1%, and domestic debt from 53.7% to 51.5%).

Now the question is: why Pakistan needed higher foreign debt in FY19 and why higher fiscal deficit was in the same period? To understand this, one needs to see the total external scorecard for it –the change in foreign reserves of the country minus total external debt and liabilities increase.

During Jan 2017 to Jun 2018, the country’s total external debt and liabilities increased by $19.5 billion and total foreign reserves fell by $6.8 billion. This means the total external scorecard dipped by $26.3 billion. The commutative current account deficit in that period was $27.8 billion.

The situation posed a serious challenge to the new PTI government. The current account deficit in FY19 was $13.8 billion and the external scorecard was minus $13.0 billion – external debt increased by $11.1 billion and reserves were down by $1.9 billion. This explains why external debt kept on growing in FY19.

During FY20 (Jul-19 to Sep-19), things have begun to improve. There is a sharp reduction in the current account deficit. For the first time in 1QFY20 since 2QFY15, the change in reserves minus debt increase (external scorecard) is positive – at $209 million. Needless to say, the lower fiscal deficit will help reduce the need for overall debt, and the better current account number will yield better external scorecard. Another good sign is that government domestic debt, net of cash balances, increased by mere Rs240 billion in Jul-Sep and the foreign debt is growing. With portfolio investment pouring in government debt, eventually banks have to find borrowers in the private sector. This will make for further industrialisation and higher productivity.