Spearhead Analysis – 31.03.2016

debtPakistan’s ‘debt crisis’ is the subject of much debate and speculation. The Spearhead research team came up with some questions and sought answers from experts. The consolidated input received is given below with comments from our team.

As a conclusion some excerpts from papers by economists and financial experts have been included.

There is no doubt that the government is aware of the full spectrum of the economic situation including the debt pitfall. The government has managed to make the economy viable and poised for growth. Mega projects that can be game changers are in the pipeline and international financial institutions have expressed confidence in Pakistan—especially after the improvement in the internal security situation. 

What is the country’s loan situation, both internal and external?

 March 2015: Total debt liability in Rupee terms stood at 19 trillion (foreign debt: 6.4 trillion and domestic debt a little over 12 trillion).

 Debt to GDP ratio: 66.40%. We paid $6.80 billion in debt servicing in FY15 ($5.9 billion in principal and $915 million in interest payments). Meaning, 47% of country’s revenues were consumed in debt servicing.

September 2015: External debt climbed to $66.50 billion or a little over 7 trillion – a jump of nearly 10% in 6 months!

State Bank’s own report FY15:— Public debt to GDP ratio: 64.80%.  Pakistan’s indebtedness compares unfavorably with other emerging economies.

Public debt to GDP although on the higher side is still under control somewhat. For example in India the figure is around 66.1% and Srilanka the figure is 75.5%.What is worrying is the debt to revenue ratio  which is in excess of 500% which is the real cause for concern and might accelerate the debt to GDP ratio as well.

Given present projections, when is the country expected to enter the danger zone as far as loan repayment is concerned?

Could have entered the danger zone by the last quarter 2016 but oil prices have been the saving grace and barring any dramatic changes, we should be able to get through 2017, even if we decide to take a break from the IMF program. Meaning that we negotiate the next package after a gap of a year (not likely though as the government seems keen to extend the program after the current one finishes).

The danger zone really starts in 2018.

  • First, Paris debt relief comes to an end.
  • Second, balloon repayments of Euro/ Sukuk bonds start in 2018.
  • Third, the grace period of the current IMF loan of $6.6 billion comes to an end in 2018.
  • Fourth, repayment of CPEC commercial financing may reach a high level.

Given present projections will Pakistan be able to repay these loans

Debt sustainability is questionable. We have failed to shore up competitiveness, so exports are declining while imports in quantum terms are increasing. Meaning, if oil, gas and commodity prices were to increase it could be disastrous.

Further the perception persists that spending has been in a non transparent way, not properly prioritized and on projects that require subsidy rather than being self-sustainable.

The total external debt is expected to cross $100 billion by 2019-20. This includes CPEC financing .The cost of financing the debt repayment and current account gap is projected to increase from $6.6 billion in 2015-16 to $13 billion by 2019-20.

Unless exports increase by 60 % to $38 billion debt servicing will be difficult.

What are the ramifications and consequences for the country, should Pakistan not be able to repay these loans?

We saw what happened in Greece despite it being a Euro-Zone member. Pakistan has no European Union or the European Central Bank to come to its rescue. A default could be disastrous with the potential risk of a run on the banks and a free fall of the Pak Rupee.

Pakistan will be hit hard by austerity measures forced upon the nation by its debtors. Severe limitation will be put on all type of government spending which will have a huge impact on the government’s ability to finance any of its operations and projects. These measures will bring the treasury down to its bare bones and will potentially be the start of a downward spiral of the economy as budget cuts will ripple across the economy lowering incomes and thus consumption which will in turn then again negatively affect incomes. This sort of a negative feedback loop will prove to be extremely detrimental and induce a rut which will be very hard to get out of. The brunt of the damage will be borne by the youngest in the demographic pyramid and we will have a ‘lost generation’ devoid of any meaningful opportunities for employment.

Pakistan will have to go back to the IMF in 2018 after elections. Depending on the stance of the USA the conditions could be tough. There could be severe pressure and coercion on issues.

Between now and the projected time when Pakistan enters the danger zone, what needs to happen to push back the boundaries of this approaching catastrophe?

Stop imprudent spending on un-sustainable projects.

Shore up competitiveness to revive exports.

Resurrect PSE (Private Sector Enterprises) to cut down recurring losses.

Raise tax to GDP ratio.

Cut back on luxury and non-essential imports.

Optimize on the low oil price opportunity the way India and Bangladesh are doing, not significantly lower prices to consumers to avoid stoking demand and instead use the savings to lower industrial tariff in order to boost manufacturing, exports and employment generation.

Focus on increasing exports through exchange rate adjustment and proper pricing of energy.

Stop seeking high cost external debt. Negotiate favorable terms of commercial loans with China.

What is required is drastic structural change in our economic structure. Right now productivity levels are shambolic across the board as a result of red tapism and concentration of power within a few. Expecting progress in the short to medium term is highly unlikely in terms of generating revenue therefore restructuring our liabilities and finances is the only feasible solution with in this short time period. Progress on structural change should also be ramped up as restructuring is only a short term fix and in the long run only robust private sector empowerment will lead to an improvement in fundamentals.

Are there any other special considerations that should be noted?

The real concern which is surfacing gradually is of ‘hidden debt’. The more one probes, the more it becomes evident that governments have not been accounting for sovereign undertakings, sovereign guarantees (federal and provincial) and debt instruments other than direct loans (bonds, saving schemes, long term agreements with accompanying liabilities, potential penalties, etc) in their debt fact sheet. This is not only dangerous but also presents an inaccurate picture on the risk of debt facing the country!

There is a danger that the Government will go for pump-priming the economy from the next budget onwards by increased domestic and external borrowing.


Some excerpts from papers written on the debt situation by economists and financial experts:

Pakistan’s debt profile may worsen in the next five years. Conservative estimates suggest that Pakistan’s external debt and liabilities could reach $105 billion or 387 percent of export earnings by 2019-20 from $65.2 billion or 271 percent of export earnings in 2014-15.

External debt repayments are going to rise because of the maturing Eurobonds/Sukuk, start of the repayment of Paris Club debt and the repayment of the current IMF loan. If the maturing bonds of 2006 and 2007 as stated by the SBP are going to create repayment risks from 2016 onward, then what will happen to the bonds amounting to $3.5 billion issued since 2014? As far as Paris Club debt amounting $12.5 billion is concerned, it has been accumulated since the inception of this country and more so during the decade of the 1990s.

The debate on the definition and size of the public debt and its sustainability continues to be controversial. For example whereas the government reports a lower public debt to GDP ratio than the SBP (which states that it is 64.4%) the inclusion of contingent liabilities on account of guarantees, the debt of Public sector enterprises, the circular debt and the outstanding tax refunds the ratio touches 75%, making the debt to revenue ratio close to 525%. Estimates suggest that if the tax to GDP ratio had remained at the level of 12% (now barely 10%) the level of total debt would have been almost 14% lower.

Presently, interest payments (including those pertaining to domestic debt) are now consuming 36% total revenues and in excess of 46% of tax revenues, the equivalent of 5% of GDP, with 70% of debt being of the domestic variety. The increase in overall debt, and particularly of domestic debt, has not only been to fund capital/development expenditures but also to finance recurring expenditures.

Although the ensuing inflation would be painful, domestic debt can theoretically be paid off by printing money to pay off the holders of debt but is extremely unpractical and will put a huge strain on the economy. However, such an option is not available in the case of external debt, whose servicing is a more daunting challenge: external account has historically been the Achilles heel and there has been heavy dependence upon.

The generosity of the international community and repeated IMF rescue programs (19 IMF bailouts since 1958), for the following reasons:

a) The imperatives of a security state which has resulted in the diversion of a large share of resources away from critical expenditures on social services (i.e. education, health and skill formation to upgrade the quality of human capital), greater centralization of administrative and financial powers and the distribution of resources and continuing conflict with the federating units;

b) An economic structure that has patronized rent-seeking is inward looking and has been reluctant to create a more equitable society. This elite structure has been unwilling to contribute, on the basis of capacity, the resources required for instituting a more just society. This arrangement also actively promoted the creation of an industrial structure that discouraged the development of competitive markets through entry barriers and has been unable to compete in global markets without continuing state support and protection or produced low value added products for exports.

c) The low levels of investment and domestic savings; the latter resulting in heavy reliance on external assistance and borrowings for financing investments.

d) A low level of commitment to institutional strengthening that has affected the quality of governance. Weak governance and lack of institutional capacity to prioritize, plan and design development strategies resulted in the poor selection of economic and social projects/ programs by ineffective implementation and deficient oversight and evaluation.

e) The relatively low rates of domestic public and private savings and an overly protected industrial structure has contributed to persistent fiscal and external deficits that has raised debt levels and the debt servicing requirements.

f) Fortuitous events internationally at critical moments of the country’s history that led to large inflows of capital on concessional terms, facilitating fiscal indiscipline and the frequent postponement of fundamental reforms.

Our external debt has ballooned by US$ 25 billion in the last 8 years. The primary causes for such an outcome have been the continuously large current account deficit-owing largely to a poor showing of our exports sector (for a variety of reasons including policy weaknesses), requirements to finance interest and debt repayments, a sharp slowing down of non-debt inflows in the form of FDI and grants and heavy borrowing to build up foreign exchange reserves.

As a result of this relative acceleration in debt accumulation and the uninspiring performance of our exports the servicing of external debt is now absorbing approximately 27% of export earnings, rising from US$3.2 billion to in excess of US$ 7 billion in 2014-15.

Our credit ratings are monitored and revised continuously, being dependent upon the government’s management of the economy. The rates at which we can borrow can be different every time we enter the market and will depend upon the market’s perception of the economy’s performance. Hence, despite the ‘supposed’ improvements highlighted above, we still ended up, one and half year later, paying the same rate as for the last bond issue. What should be noted is that although Pakistan’s rating for the last bond issue did improve to B3 from Caa1 as per Moody’s, and the country has been assigned a stable outlook due to a continued strengthening of the external payments position; and sustained progress in structural reforms under the government’s program with the IMF, however, the timing of the bond issues is what has raised rates on the bonds with the last bond being offered at 8.25% and then immediately started trading on a discount. Bond financing is a viable means of meeting financing needs but the rate and timings should have taken into account the global economic scenario and positioned accordingly.

The need for liquidity or for settling immediate obligations should not be driving decisions to raise more external debt rather existing debt should be restructured. Presently, the country has adequate foreign exchange reserves the bulk of them in the form of a non-interest bearing assets, cash.

Though the fall in oil prices is indeed a gift, but the attendant consequence of this fall of price has not been taken into consideration i.e. how this will impact the global economy in particular the Saudi economy, and particularly its infrastructure projects which employ hundreds of thousands of Pakistanis. One should therefore expect that many of these projects will start to fold up, and a greater part of this labor force can be expected to head back soon.

(The Spearhead team is grateful to Dr Salman Shah, Dr Ashfaq Ahmed, Dr Kamal Monnoo, Dr Hafiz Pasha and Mr Shahid Kardar for their input)