Not all debt is created equal

For those following international economic developments, terms like fiscal cliff and debt ceiling may not be news. When one looks at the numbers, countries like USA, Japan and Ireland seem to have debt issues much worse than Pakistan’s. So, it is reasonable to ask how big of a problem is Pakistan’s debt relative to other countries? With a debt to GDP ratio 300 bps lower than Germany’s, is Pakistan’s economy faring better than theirs? Clearly, the numbers don’t present the whole picture.
A country’s credit rating is a reflection of multiple economic indicators, not least of which is its public debt to GDP ratio. Another important factor is government’s capacity to collect tax revenue; a measure that Pakistan fails at miserably. To elucidate this point, consider Italy whose public debt is more than hundred percent of its GDP (compared to Pakistan’s 60 percent) but that country’s tax to GDP ratio is more than twice that of Pakistan.
Just as important is the source of debt for the country, whether the debt is owed by the government, or private institutions and consumers. So on surface, given its 512 percent debt to GDP, the Japanese economy may seem to be on the verge of collapse. However, the net government debt stands at just a quarter of this tally.
Another equally intriguing statistic is the external debt of a country. Luxembourg’s external debt to GDP is more than three thousand percent of its GDP; which makes Pakistan’s external debt look like peanuts. But, Luxembourg is a net international creditor, which means other countries owe it even more money than it owes to the rest of the world.
So the reason Pakistan’s 30 percent external debt to GDP is a bad omen is that it shows a low willingness among the comity of nations to lend to this country. Such willingness is driven by the credit worthiness of the borrowing government and its ability to repay. In Pakistan’s case, the higher proportion of domestic debt indicates government’s increasing reliance on monetary expansion and reluctance to lend on the part of international lenders.
To top it off, Pakistan’s domestic public debt is predominantly short term. Heavy reliance on T-bills leaves the economy exposed to the rollover risk associated with regularly maturing debt that has to be bridged through new loans.
Lastly, it is pertinent to highlight that at present the new debt being taken on by the country; both domestically and through international lenders such as the IMF is only going towards paying off older loans. In a nutshell, the climbing loan tally is not directly linked to any new economic activity that would add to the country’s ability to repay.