by Senator Mohammad Ishaq Dar
Economic indicators are always open to interpretation and debate.
The case in point is the public debt management. Some inherently skepticalanalysts have gone overboard with predictions of doomsday scenario for Pakistan’s debt and liabilities. Not surprisingly, their analyses are largely built on misinterpretations rather than facts. Itmust beunderstoodthat the contours of public debt management are complex. This process involves dealing not only with budgetary requirements of the country but also maintaining a fine balance between cost and risk, developing an efficient and deep secondary debt market, and maintaining the public debt at a fundamentally sustainable level.
As I had highlighted in a press article in March 2016, debt management has taken special emphasis in our public financial management. This is so because persistently large fiscal deficits of previous successive governments have caused a significant growth in the volume of public debt over the past few years. The vision of our government is not just to bring the debt-to-GDP ratio in line with existing statutory limit of 60 percent, but also to scale down this limit to 50 percent in 15 years, starting from FY2018-19. Side by side, we have also put statutory upper limit of 4 percent on federal fiscal deficit. Necessaryamendments in Fiscal Responsibility and Debt Limitation Act (FRDLA)in this regardhave been passed in June 2016 by the Parliament. Suchfar reaching measures are going to bring further structured discipline in our debt management. As for now, let me present below few points to address common misperceptions.
Most of the public debt is domestic and not external
At the outset, there is a need to have clear distinction between domestic and external components of public debt, since each category carries a different risk profile. As at end June 2016, the country’s gross public debt was Rs.19.68 trillion and netpublic debt stock was Rs.17.83trillion, of which the net domestic component was Rs. 11.78 trillion and the external component was Rs.6.05trillion. Thus, net domestic debt constituted around 66 percent of net public debt, while the remaining 34percent was external debt.
Fresh mobilization has a longer maturity profile
Government is adhering to the MediumTerm Debt Management Strategy (MTDS) for the period 2015/16 – 2018/19 to make public debt portfolio more sustainable. As per MTDS, the government is focusing on extending the average time to maturity of domestic debt through mobilization mainlyin the form of medium to longer tenor instruments like Pakistan Investment Bonds (PIBs). Medium to long term debt, whichconsists of permanent and unfunded debt, amounted to Rs.8.6 trillion as at end June 2016, witnessing growth of 13.7 percent year-on-year. In contrast, the short term debt, which composed of primarily treasury bills, increased by only 8.4 percent year-on-year.
Refinancing risk was one of the most significant issues in Pakistan’s public debt portfolio, driven primarily by the concentration of domestic debt in short maturities at the endofJune 2013. The refinancing risk of the domestic debt is reduced significantly at the end of June 2016 as indicated by percentage of debt maturing in one year which reduced to 51.9 percent compared with 64.2 percent at the end ofJune 2013. Accordingly, Average Time to Maturity(ATM) of domestic debt has increased to 2.1 years at the end of June 2016 as compared with 1.8 years at the end of June 2013.In line with the MTDS, the government intends to increase the ATM further keeping in view the cost vs.risk trade off.As any financial expertwouldagree, lengthier the maturity profile of domestic debt, lesser the interest rate and refinancing risks. In addition,longer maturities in PIBshelp in deepening the debt capital market and will assist in building a yield curve to bring more price stability.
Servicing burden has been reduced
The timing of this shift in maturity profile is also helpful. The current low domestic interest rate environment has enabled the government to manage its debt servicing cost, going forward. Certainly, the cost of extending the incremental ATM is relatively smaller than the gains on account of reductionin refinancing risk and protection against increase in interest ratesas domestic debt re-fixing in one year isreduced to only 52.8 percent at end June2016, compared to 67.2 percent as at end June2013. An important aspect of having more domestic debt is that it inherently has a low intensity of roll-over risk compared to the external debt. Specifically, the debt denominated in local currency can be readily refinanced with an appropriate mix of treasury bills and investment bonds. The fortnightly auction of T-bills and monthly auction of PIBs of various maturities provides a well-functioning and systematic avenue to facilitate refinancing.
Refinancing/repayment burden is staggered, not concentrated
Here, it is also important to highlight that the entire amount of debt does not mature on the same day. Rather, it becomes due over a period of time which enables the government to plan its schedule of repaying or rolling over existing debt and go for a new period which is decided taking into account the prevailing cost of borrowing, prospects of rate for coming periods and matching it with tax collection pattern.
The burden of public external debt has fallen
Some analysts are often misquoting the level of public external debt in media as US$73 billion. They lump together public debt with private debt, which includes foreign exchange borrowings of banks as well as non-financial private sector. The stock of public external debt as at end June 2016 actually stood at US$ 57.7 billion, up from US$ 48.1 billion as at end June 2013. This represents a cumulative annual growth rate of only 6.3 percent per annum. Certainly, this cannot be termed as an exponential growth, as claimed by a few. It may also be noted that a part of this increase has come from IMF debt, which has been taken only for balance of payment support, repayment of pending instalments due to IMF of loan taken by previous government in July 2011and not for budgetary financing. Finally, any unbiased financial expertwould endorse that instead of reading out the nominal growth of external debt, it must be seen how its volume has grown relative to the country’s foreign exchange (FX) resources, FX earnings and GDP. Similarly, the servicing burden must not be viewed in isolation but relative to FX earnings. Even a cursory look at the Table below would corroborate our view that despite increasing in volume, in essence and relative to main economic parameters/indicators like GDP and reserves etc., the relative external debt burden is much less today than it was three years ago
Key Public External Debt Indicators (in percentage (%))
June 2013June 2016Public external debt/GDP20.820.4Public external debt /SBP reserves8.03.2Public external debt /Total reserves4.42.5Servicing of public external debt/forex earnings11.18.4Servicing of public external debt /Export earnings22.615.9
Reduction in Net External Indebtedness
A pragmatic and realistic approach is to measure the “net external indebtedness” of the country which is the difference between external public debt and official FX reserves. As at end June 2013, the SBP FX reserves were around US$6 billion, out of which US$2 billion were through short term FX swap with a friendly country maturing in less than 60 days. Therefore, practically SBP’s true FX reserves were US$ 4 billion as at end June 2013 against which external public debt stood at US$48.1 billion, thus net external indebtedness on June 30, 2013 was US$ 44.1 billion(US$ 48.1 billion -US$ 4.0 billion). As at end June 2016, the FX reserves of SBP were US$ 18.1 billion and external public debt stood at US$57.7 billion, thus net external indebtedness was US$ 39.6 billion (US$ 57.7 billion-US$ 18.1 billion). Therefore, net external indebtedness of the country improved by US$4.5 billion by end June 2016compared with end June 2013.
The importance of FX reserves of a country can hardly be over emphasized. FX reserves not only enable the central bank to ward off speculative attacks on its currency but also by dampening volatility in the domestic foreign exchange market they actually contribute towards keeping the inflation down thus leading to rationalization of domestic interest rates. During the last three fiscal yearsto end June 2016, the external public debt has gone up by US$ 9.6 billion, the FX reserves of SBP have increased by US$ 14.1 billion in the same period thereby improving the SBP reserves, net of increase in public external debt, by US$ 4.5 billion. Further, the present government has repaid around US$ 12 billion of external debt till end June 2016, which was mainly related to the borrowings of the previous governments. Despite these heavy repayments, the FX reserves of the country have risen to more than US$ 23 billion, of which SBP reserves were US$ 18.1 billion at end June 2016, which is equal to over five months of import-cover as compared to around one month of import-cover in June 2013 when the SBP reserves (net of temporary swap of US$ 2 billion) stood at US$ 4 billion. At the time, some analysts were predicting that Pakistan would not have sufficient external resources to fulfil its external debt obligations and would head towards default by June 2014.
Finally, to highlight the importance of reserves, let me place a very simple situation. Suppose,if the country does not have sufficient FX reserves, the obvious repercussions would be that the international risk profile of the country would take an adverse hit. All international development partners would immediately stop balance of payment/program lendingbusiness with the countryand the credit rating agencies would downgrade their ratings by multiple notches due to zero or lowsolvency and importers would require to get their Letters of Credit confirmed from foreign banks at exorbitant charges etc. Bottom line being that the country will be declared high risk with negative outlook as was the case in June 2013. This simple example should be sufficient to explain that having external liquidity in the form of FX reserves is paramount for stableeconomies.Additionally, if the FX reserves are increasing coupled with reduction in net external indebtedness,then it is a case of dual advantage as with Pakistan in last three fiscal years to June 2016.
Unlike headlines, development funding dominates
Over the past three years, many skeptic analysts have been citing the IMF debt and the commercial borrowings as the prime reason behind external debt growth which is incorrect. Within external public debt, the multilateral debt accounts for largest share amounting US$ 26.4 billion and Paris club debt amounting US$ 12.7 billion, constituting combined share of 68percent of the external public debt as at end June, 2016. While IMF loans and Eurobonds/Sukuk have dominated the headlines, their outstanding amounts were only US$ 6.0 billion and US$ 4.6 billion respectively, having share of only 18 percent as at end June 2016. The remaining US$ 8.0 billion of external debt includes bilateral and commercial loans. It should also not be forgotten that bulkof these loans were actually used to repay similar loans taken by previous governments from IMF in addition to retiring/repaying Eurobond of US$ 500 million issued by General Musharraf’s dark era.Multilateral loans include significant amounts from creditors like the World Bank and ADB. Here it is important to recall that these International Financial Institutions (IFIs)had virtually ceased business with Pakistan by early 2013 due to Country’s macroeconomic instability, high risk factor and very low FX reserves but havere-engaged in the last three years with Pakistan as per their respective Country Partnership Strategies after Pakistan has managed to introduce structural reforms leading to significant improvement in macroeconomic situation. These partnerships are primarily aimed at removing structural bottlenecks from Pakistan’s economy and to help us in the areas of energy, taxation, ease of doing business, trade facilitation, education and promotion of small and medium enterprises (SMEs). These lending programs will be instrumental in enhancing Pakistan’s potential output by promoting efficiency and productivity. These programs are, thus, simultaneously adding to the debt repayment capacity of the country. It may also be highlighted that these loans are also concessional and dominated by long term maturities and, therefore,do not add much to the country’s debt servicing burden.These concessional external loans have been used to retire relatively more expensive domestic debt.
Scheduled repayments of external debt are within manageable level
As of today, external debt servicing obligations for Pakistan are not more than an average of US$ 5 billion per annum until 2021. Keeping in view the track record of the country, this amount of repayments should not raise any concern. Pakistan has successfully met higher obligations in excess of US$ 6 billion per annum in FY 2013 and FY 2014, even with much smaller volume of FX reserves. As stated earlier, these higher servicing amounts pertained to loans taken by the previous governments. Presently, the country’s FX reserves are at a historic high of around US$ 23 billion (as opposed to previous all-time high of US$ 18.2 billion in July 2011 which included US$ 7.5 billion front loaded disbursements from IMF to Pakistan under SBA facility) and, therefore, the scheduled repayments are well within manageable level.
A word on sustainability
Regarding sustainability of debt, the Debt Management Office in the Ministry of Finance keeps track of external debt by looking at standard indicators of solvency and liquidity. I have already presented in March 2016 article a few indicators in a table. It is, however, important to discuss some other indicators as well. In terms of liquidity, the most important ratio to look at is the amount of debt maturing within one year as a percentage of official FX reserves. There has been a marked improvement in this ratio as it has declined from an alarming 69 percent in June 2013 to only 32 percent at end June2016. More importantly, the ratio of debt maturing within one year to SBP’s Net International Reserves (NIR) has shown immense improvement as it now stands at 77percent; back in June 2013, SBP’s NIR was negative.
One must keep in mind that Pakistan is a developing country which needs to pursue high growth objective to expand its capacity, enhance job creation, stimulate higher per capita income, reduce poverty and improve competitiveness. Consequently, running a budget deficit becomes a necessity. The other option is to stifle growth by curtailing development expenditures that can in turn have socio economic implications. Every year this deficit is pre-approved by the Parliament at the time of passage of Finance Bill. However, it must be remembered that a deficit budget automatically entails reciprocal addition to public debt. Thus the absolute number of public debt cannot decline as long asPakistan is a budget deficit country.The net addition to public debt during the last three years is Rs. 4,342 billion and is primarily on account of deficit budgetsapproved by the Parliament aggregating to Rs. 4,195 billion for the three years ended in June 2016. The remaining balance is due to other, non-budget deficit factors like, net exchange losses that may occur due to currency fluctuations both domestically and internationally.
To provide some historical perspective in this regard, Pakistan’s gross public debt was Rs. 6,126 billion, as of June 30, 2008, while net public debt was Rs. 5,650 billion which included net domestic debt of Rs. 2,798 billion and external debt of Rs. 2,852 billion. By the end of FY 2012-13, gross public debt increased to Rs. 14,318 billion while net public debt increased to Rs. 13,483 billion, thereby the previous government contracted net debt of around Rs. 7,833billion during its term (2008-13), at an annual compounded growth rate of 19.0percent. The present government started its first fiscal year in 2013 with inherited gross public debt of Rs. 14,318 billion and net public debt of Rs. 13,483 billion comprising of external public debt of US$ 48.1 billion (Rs. 4,797 billion) and net domestic public debt of Rs. 8,686 billion. During the period from July 2013 to June 2016, the gross public debt has grown to Rs. 19,678 billion while the net public debt has grown to Rs. 17,825 billion, out of which the external public debt was US$ 57.7 billion (Rs. 6,051 billion) while net domestic public debt was Rs. 11,774 billion. Thus, there is a net increase of Rs. 4,342 billion in total public debt, inclusive of an increase of US$ 9.6 billion in external debt. This constitutes an increase in net public debt at an annual compounded growth rate of 9.75percent during first three years of the present government, compared to 19.0 percent during the previous government.The Net Debt to GDP ratio as at June 2008 was 53.1% which had increased to 60.2% in June 2013 when the present government assumed office. During the period from July 2013 to June 2016, the Net Debt to GDP ratio has remained unchanged at 60.2%, thus showing no further deterioration, which is a clear sign of improved debt sustainability.It is worth highlighting here thatthe net public debt figuresprovided in this article have been calculated in accordance with international best practices and methods used by the IMF as well as various developed and developing countries around the world.
It is important to note thatat the time of the general elections in 2013, Pakistan’s economy was in dire need of stabilization. Therefore, immediately after assuming office, the present government undertook remedial measures and structural reforms, in order to stabilize the economy. These measures included broadening the tax base, reduction in untargeted subsidies, building up of Foreign Exchange reserves, restructuring Public Sector Enterprises and reducing the fiscal deficit. Despitecurtailing thefiscal deficits from 8.2 percent to 4.6 percent of GDP in three years to June 2016, the present government has been able to enhance Federal Development spending from Rs. 348 billion in FY2013 to Rs. 800 billion for FY2017, in order to give a push to the GDP growth which was recorded at 4.7 percent for FY2016, an eight years high. Likewise, cash income support to most vulnerable also increased from Rs. 40 billion to Rs. 115 billion in three years to end June 2016. Inflation, which was in double digits average (2008-13) when PML(N)government assumed office in June 2013, has been brought down to less than 3 percent in FY 2016, the lowest in decades. On the revenue side, tax collections have increased by 60% over the last 3 years, a 20% average annual increase, from Rs. 1,946 billion in FY 2013 to Rs. 3,112 billion in FY 2016, as opposed to 3.38% increase in FY 2013.
International organizations have also recognized the country’s economic turnaround. Recently, Standard & Poor’shas raised Pakistan’s long term sovereign credit rating to B from B minus, with stable outlook, due to improved economic outlook and better fiscal and external account.IMF has raised its GDP growth forecast for Pakistan for FY 2017 from 4.7% to 5%, and ADB too has raised its GDP forecast for Pakistan for 2017 to 5.2%. World Bank has also projected 5.2% GDP growth for Pakistan in FY 2017 and 5.5% in FY 2018. Furthermore, a Harvard University study has projected 5.07% annual GDP growth for Pakistan till 2024. Our target is to gradually increase the GDP growth rate tobetween 6 to 7% by FY 2018-19.
Certain quarters in the media repeatedly claim that government raises its external debt at expensive rates. However, this is contrary to reality. Large portion of the external loans are contracted at extremely low rates and attractive terms. This is evident from the average cost of the total external debt obtained by present government which comes to around 3.1 percent excluding grants and 2.9 percent including grants. Furthermore, in October 2016, our government issued a US$ 1 billion International Sukuk at 5.5 percent, the lowest ever rate for any bond or Sukuk issued in Pakistan’s history. Thus cost of the external debt contracted by current government is not only economical but is also dominated by long term funding. To establish the fact that this government has slowed down the pace of debt accumulation, the declining trajectory of external debt to GDP ratio is a sufficient proof.
Fiscal and Current Account deficits are inevitable for a developing country. The challenge of good economic management is to keep these two deficits within sustainable limits, so that the former would not lead to unbridled growth in public debt while the latter would not lead to external liabilities that cannot be supported by prospective capital flows. Our debt management policy is precisely balancing these two ramifications of deficits.
The important aspect of our debt management is the strong adherence to fiscal discipline, which centers on an unquestionable resolve for reducing the budget deficit. Results speak for themselves;the fiscal deficit of 4.6 percent of GDP recorded in FY 2016 is just over half of the deficit of 8.8 percent back when the present government assumed office in FY 2013 while the target is to bring it below 4 percent in the current FY 2017. Having said that, addressing the below-par performance of exports, attracting more FDI and stimulating domestic privateinvestment remain priority agenda of the government. Corrective measures already taken in these domains willfurther strengthen the country’s debt sustainability profile in the years ahead.Taken collectively, the above evidence is sufficient to establish that Pakistan is properly managing its debt and to convincingly dispel any notion that the country is at risk with regard to debt obligations in the foreseeable future.
(The writer is Fellow Chartered Accountant and Federal Finance Minister of Pakistan)