PAKISTAN’S public debt — both domestic and foreign — has soared like anything in recent years to Rs67.5 trillion on government borrowing needs to finance its surging budget deficit.

The State Bank data for March shows that public debt is almost three quarters of the nation’s economic output and just above 83 per cent of the total national debt of nearly Rs81tr. The present public debt stock compares with its previous levels of Rs32.70tr in 2019 and Rs39.87tr in 2021.

The finance ministry’s mid-year budget review report for FY24H1, for example, reveals that government’s interest payments in the first half of the fiscal year jumped by 64pc to Rs4.22tr from Rs2.57tr in the same period a year before, brin­ging further pressure on the budget and forcing the authorities to massively cut development spending to meet an IMF programme goal of showing a primary surplus of 0.4pc of GDP. The primary surplus represents net current revenues less current expenditures excluding interest payments on government debt.

A report in the Express Tribune quoted official sources as saying that the total debt payments this year may spike to Rs8.3tr against Rs7.3tr booked in the budget. Over time, debt servicing costs have grown from 4.8pc of GDP in 2019 to 6.9pc last year. During the same period, debt payments have jumped from 51pc of the federal tax revenues to 81.4pc.

According to SBP data for March, debt is almost three quarters of the economic output

With the government running an average fiscal deficit of 7.33pc of GDP, and primary deficit averaging 1.96pc since 2019, the surge in its borrowing requirements does not come as a surprise.

Many like Sayem Ali, a member of the recently constituted advisory committee to prepare a homegrown plan for economic recovery to share with the IMF ahead the budget for FY25, believe that unsustainably higher fiscal deficit is at the heart of the country’s growing indebtedness.

“You can’t get out of this situation without tackling fiscal deficit, and fiscal issues cannot be dealt with without effectively taxing all undertaxed and untaxed sectors of the economy and finding a solution to our energy sector problems. Nothing else will work out. Privatisation of state-owned enterprises and withdrawal of subsidies will provide temporary relief, but our need for more debt will not go away without taking care of our tax and energy sector issues,” he concludes.

Analysts argue that the major burden of debt payments is coming from domestic debt of Rs43.43tr. “Domestic debt is almost two-thirds of the total public debt and accounts for nearly 85pc of the interest burden owing to the high interest rate environment in the country,” says an economist who didn’t want to give his name. “The government’s reliance on domestic banks to fund its fiscal deficit has increased manifold due to drying foreign official and private flows.”

The Profit Magazine reported last week that the government borrowings from banks for budgetary support had jumped by a staggering 116pc from Rs3.15tr between July and mid-May last year to Rs6.79tr. The SBP attributed it to slow foreign inflows and less-than-targeted revenue collection. The government’s growing reliance on banks for financing its budget is often said to have created a “systematic risk” for the country’s financial system. In its second review of the just-concluded stand-by arrangement (SBA) programme, the IMF said banks’ sovereign exposure has continued to increase from 48pc of assets at end-FY21 to 57.4pc at end-January 2024, crowding out credit to the private sector.

Pakistan Banking Association (PBA) CEO Muneer Kamal highlights that back in 2008, only 24pc of the government borrowings to cover its budget deficit came from the banking sector. “Today, it borrows 83pc of its total loans from the banks to fund its deficits. Likewise, over 90pc of the banks’ investments of Rs8.7tr in 2019 was in government debt securities,” he points out.

“This exposure has now increased to Rs26tr. It shows the size of the government dependence on domestic bank borrowings. The banks have become a sort of ‘pillar of the state’, and this is not a good thing at all,” Mr Kamal adds. He says it is wrong to blame the banks for making profits at the expense of the government by charging high interest rates. “It is due to the country’s economic conditions that the interest rates are elevated and the government has to borrow to implement its budget. We are not to blame.”

Debt trap

“We are in a debt trap,” Ayesha Ghaus-Pasha, the former minister of state for finance, argues. “Our debt is already 80pc of the GDP, compelling the government to accumulate more debt to pay back the existing loans. This is not sustainable; it is burdening public finances way too much. We are getting deeper into the trap.”

She maintains that the government must undertake deep structural reforms, effectively control expenditure, mobilise tax resources, encourage private investment, and, last but not the least, avoid temptation to improve the economy at a fast pace.

Opinion over sustainability of sovereign debt remains divided, however, as Pakistan negotiates 24th bailout from the IMF to shore up its international reserves, improve its balance of payments position, and unlock other bilateral and multilateral funding. In its second and final SBA review, the IMF projects the debt-to-GDP ratio to decrease markedly, driven by fiscal consolidation and ex-post negative real interest rates, at the end of the outgoing fiscal year. What it fails to mention is the fact that this “consolidation” has been achieved at an enormous human cost and yet there is no light at the end of the tunnel.

That said risks to debt sustainability remain acute given very large gross financing needs and the persistent challenges in obtaining external financing, and that real interest rates are projected to become an adverse driver of debt dynamics in the coming years, the IMF adds.

“Provided that programme policies are sustained over the medium term and assuming adequate multilateral and bilateral financial support, public debt would remain sustainable and on a downward path,” it notes.

However, Ali Salman, the founder and CEO of Islamabad-based Policy Research Institute of Market Economy, believes that the country’s debt is now unsustainable because debt servicing, which should be under 30pc of total budget revenues for debt to be sustainable, has now soared to over 60pc.

Listing three major factors — uncontrolled government expenditures, inability to increase tax revenues, stagnating economic growth and higher interest rates — that are continuously driving debt accumulation and debt servicing costs, he points out that Pakistan’s debt profile has largely changed in the last 15 years. “Earlier, long-term and low-cost external debt used to constitute 60-70pc of our total debt. Now the situation has reversed and short-term, expensive domestic loans have replaced affordable external debt.”

Naved Hamid, a development economist, has a different view on the country’s debt sustainability. He says there is no question of default on domestic debt and it can be taken care of one way or the other. The problem, he maintains, is with the external debt. Yet, he adds, the risk of a default on the country’s foreign debt payments is next to none at present because of the help coming from the IMF.

“Now the question is why it has become so difficult to service the external debt and why this will continue to be a challenge in the future. It is because external debt has largely been used to support government consumption rather than expand public investment and boost productivity. Poor export performance over the decades too has weakened our capacity to service the debt through our own earnings despite significant growth in remittances. Then, foreign investors are also not prepared to venture in Pakistan due to economic conditions which constrain our capability to rake up non-debt creating international flows. On top of that, no one is ready now to give us more money so we can pay off our old debt as our capacity to leverage our geopolitical position has weakened.”

Consequently, Mr Hamid notes, Pakistan is now stuck in a low growth equilibrium of 2-3pc, which is not sustainable either economically or politically but any attempt to grow the economy beyond, this will just result in another crisis. “This is a very critical time for our economy; we have no choice but to take difficult decisions to broaden the tax net, boost productivity and exports, curtail wasteful government expenditures, and fix our energy sector if we want to survive. The question is: are we ready to take this difficult route?”

The high degree of indebtedness has made Pakistan more vulnerable even to slightest of economic shocks and forced the government to reduce socio-economic development investments to alleviate poverty. Salman says fiscal deficit and high indebtedness of a sovereign slow down economic growth and fuel inflation and unemployment.

“The cost of debt repayments is largely borne by citizens in the form of heavy indirect taxes, such as the taxes and levies on petrol. If Pakistan’s debt is sustainable, it is only so at a huge human cost.”

Published in Dawn, June 2nd, 2024