Debt is good as far as it yields positive returns. But that does not seem be the case for Pakistan. The governments primary debt balance - i.e. fiscal deficit before interest payment - is in deficit which implies that the cost of invested funds is higher than growth in revenues, and so, consequently, the debt burden will not ease.
The countrys total debt-to-GDP ratio, which declined to 55.4 percent of GDP by FY07, is back on an upward trajectory and reached 60.6 percent by FY10. Within the first quarter of this year, debt liabilities have grown by 6.5 percent versus the full-year growth of 16.6 percent last year.
The Finance Minister fears the fiscal deficit might reach 8 percent of GDP in FY11. Taking a cue from his words, with 3 percent of GDP deficit in first half of the year, the government would need to finance Rs850 billion in the second half of current fiscal year. This can push the debt-to-GDP ratio to 61 percent or more by the years end.
Then there is the structural issue of financing the debt. In the absence of foreign flows and modest growth in permanent and unfunded domestic debt, the burden is falling more and more on floating debt, which has already increased from 40.2 percent of domestic debt to 51.5 percent during FY06-10.
Within the first half of FY11, the ratio has alarmingly increased by 250 basis points to reach 54 percent. The tightening of monetary policy and inflationary expectations are pushing interest rates up since the beginning of this fiscal year, forcing market participants to focus on the shortest (3-month papers) of the short-term floating debt, while participation in the long-term permanent debt remains elusive.
This is undesirable and poses a risk in the form of roll-over, liquidity and interest rates risk, mentioned by both the SBP, in one of its monetary policy statements, and the finmin in its latest debt policy report. This also hinders the development of the long-term yield curve which is imperative for developing a corporate debt market, as mentioned by the governor SBP in a recent interview to BR Research.
Additionally, it adversely affects the private sector, as commercial banks deploy more of their deposits in government securities at the cost of private credit off-take. Government financing from the central bank exerts upward pressure on demand, which fuels inflation as well putting a strain on the balance-of-payments through a surge in import demand.
This structural imbalance in debt has to be kept under a watch, as it is likely to deteriorate further in the second half of the current fiscal year.
If the government keeps its promise of freezing its SBP borrowing at September 2010 levels, immense pressure on commercial banks for fiscal financing will push interest rates further north. It will also further strain the governments ability of debt servicing, apart from leaving nothing on the plate of the private sector.
If the government doesn fulfill its commitment, then additional inflation will be a natural consequence and in turn monetary policy will have to be further tightened. So, its a catch 22 situation.
History suggests that we can rely on government promises. Revenue deficit - difference of budgeted revenue-expenditure gap to actual - was supposed to be zero or in surplus on June 30th 2008 and thereafter as per the Fiscal Responsibility and Debt limitation Act, 2005.
However, it was 3.5, 1.5 and 2.5 percent for FY08, FY09 and FY10 respectively and is likely to be over 3 percent in FY11.
In the meanwhile, energy circular debt is not only adding woes to fiscal deficit, but it has also increased the governments contingent liabilities above the ceiling of 2.percent stipulated by FRDL Act. Government guarantees increased by Rs224 billion (1.53% of GDP) during FY10, mainly issued to power sector and other PSEs, with a rollover of 0.7 percent.
With these structural impediments, the total debt-to-GDP ratio may well be over 60 percent of GDP by 2012-13, a likely violation of FRDL Act.
The foreign component of debt, which remained cheaper, adjusted for exchange rate movements, compared to domestic debt in past years is far and few to come amidst heightened sovereign risk. With rising commodity prices and elusive FDIs, the financing of current account deficit is going to be a challenge.
More on foreign debt and its intricacies to follow soon in these columns.
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