ARTICLE: The SBP has recently released the estimates of the Federal Government debt as of the end of May 2020. This includes all debts which are serviced out of the Federal Consolidated Fund. There are three types of debt. The first type is domestic debt and the second type is external debt. The third type is debt owed to the IMF which has been used for providing budgetary support.
Within domestic debt there are also three types of debt. Permanent debt is long- term debt and consists of debt in the form of Pakistan Investment Bonds (PIBs) and Ijara Sukuk Bonds. It also includes the second type of rupee debt which is referred to as unfunded debt and is also long term in nature. This is mostly debt created by the flotation of prize bonds, which has now been discontinued, and savings certificates of different types by the National Savings Directorate. Short-term debt is mostly in the form of Market Treasury Bills (MTBs).
External debt is of variable maturity and owed to diverse entities including bilateral and multilateral agencies, international commercial banks and owners of Sukuk/Eurobonds floated by the Government of Pakistan. The stock of external debt is valued in rupees by conversion with the exchange rate prevailing on the date of reporting.
There is one important difference between Government debt and Public debt as defined in the Fiscal Responsibility and Debt Responsibility Act. The latter is net of the balance in deposits held by Government with commercial banks.
Based on the above definitions, analysis is undertaken below of the trends in the quantum and composition of Government debt since the time when the PTI Government was inducted into power. This debt has increased from the end of June 2018 to the 31st of May 2020 by Rs 10.3 trillion and stands at Rs 34.5 trillion. This is equivalent to an increase in the Government debt to GDP ratio between 70 percent in end-June 2018 to 83 percent in end-May 2020. The annual growth rate in this debt over the almost two-year period is above 18 percent.
How does this compare with the last two years of the previous Government? The increase in Government debt during the two years, 2016-17 and 2017-18, was Rs 5.2 trillion and the increase in the debt to GDP ratio was from 66 to 70 percent. Therefore, this ratio has increased at over thrice the rate in the first two years of the present Government as compared to the last two years of the previous Government.
Why has a faster accumulation of Government debt taken place since 2017-18? The first explanation is that the size of the budget deficits has increased thereby requiring resort to a higher level of borrowing. The budget deficits in 2018-19 and 2019-20 are close to 9 percent of the GDP. The average budget deficit in 2016-17 and 2017-18 was 6.2 percent of the GDP. Therefore, almost two-thirds of the faster increase in the Government debt to GDP ratio was due to larger budget deficits. The remainder, one-third, was the result of a much faster depreciation of the rupee which led to burgeoning of the rupee value of external debt after 2017-18.
We turn now to changes in the composition of Government debt. The first distribution is between domestic and external debt. During the five year tenure of the PML (N) Government the total net external borrowing was $18 billion of which almost $11.6 billion was in the last two years. However, despite the high level of external borrowing the share of external debt in total debt remained unchanged since 2012-13 at 32 percent due to an extremely low rate of nominal depreciation of the rupee. By the end of the tenure of the PML (N) Government the value of the rupee had appreciated in real terms by 10 percent. In fact, this was the reason for the high level of external borrowing which was necessary to sustain the artificially high value of the rupee.
There is need to recognize the efforts of the present Government in restricting the need for external financing by bringing down the current account deficit in the balance of payments from the all-time peak level of $20 billion in 2017-18, first to $12 billion in 2018-19 and to just over $3 billion in 2019-20. But for the extraordinary devaluation of the rupee in 2018-19 of 34 percent to achieve this reduction, the share of external debt in total Government debt would have been significantly smaller by the end of 2019-20 and not stayed unchanged at 32 percent.
The major change that has occurred is in the composition of domestic debt. This is the distribution between long-term and short-term domestic debt. At the end of 2017-18, the shares were 46 percent and 54 percent respectively. This has changed sharply to a 74 percent share of long-term debt and only 26 percent of short-term debt by May 2020.
What factors explain the fundamental change in the composition of domestic debt in the last two years? The first is the transformation of the tenure of the outstanding debt with the SBP of over Rs 6 trillion from short-term to long-term debt in June 2019. This explains almost 83 percent of the change in composition.
The change in the tenure of debt with the SBP is essentially in the nature of an accounting fix. It is reflected in higher SBP profits. This is visible in the extraordinary jump in SBP profits to Rs 850 billion in 2019-20, largely accounting for the 45 percent jump in non-tax revenues.
However, SBP profits on the Government debt only arise when the corresponding amount of debt servicing is transferred to SBP by the Government. Therefore, from the viewpoint of the budget deficit, higher profits are neutralized by the higher debt servicing payments.
Despite this lack of any impact, this change in the tenure of SBP debt was made to show a reduction in the primary deficit. This deficit includes SBP profits in revenue but excludes the debt servicing from expenditure. The result is a reduction in the primary deficit. The motivation to do this was largely due to the, more or less, exclusive focus on budgetary performance by the IMF on the size of the primary deficit and ignoring the budget deficit.
Therefore, it is not surprising that in 2019-20 the primary deficit has come down from 3.5 percent of the GDP in 2018-19 to 2.6 percent of the GDP, while the budget deficit has increased from 8.9 percent of the GDP to at least 9.1 percent of the GDP. It needs to be noted that the growth in public debt is determined by the size of the budget deficit and not by the size of the primary deficit.
Beyond the increase in long-term domestic debt due to conversion of debt with the SBP from short to long tenor, there has been a tendency to follow a debt management policy of issuing mostly long-term PIBs rather than short-term MTBs. This has been a very flawed policy as the interest rates had reached a peak by June 2019 due to the big enhancement in the policy rate by the SBP from 6.20 percent to 13.25 percent.
Estimates are that over Rs 3.6 trillion of PIBs, long-term savings certificates and prize bonds were issued in 2018-19 and 2019-20. The appropriate policy during a period of very high and rising interest rates is to avoid a 'lock in' situation of higher and more long-term debt servicing by floating mostly short-term paper.
Consequently, this wrong policy followed has implied that for the next three-year tenure of the PTI Government the cumulative cost of debt servicing will be higher by almost Rs 500 billion. These costs will continue even beyond 2021-22 until the PIBs of more than 3 years tenure eventually mature.
The tragedy is that the burden of debt servicing has been raised substantially at a time when resources are desperately needed to salvage the economy after the big negative impact of COVID-19. If these costs had been avoided by following the appropriate debt management policy there would have been more 'fiscal space' for providing relief and higher development spending to facilitate a faster recovery from the on-going deep recession.
(The writer is Professor Emeritus at BNU and former Federal Minister)
Copyright Business Recorder, 2020
The writer is Professor Emeritus at BNU and former Federal Minister
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