The issue of circular debt has somehow overshadowed the national debt crisis that this country currently continues to face in the form of debt servicing and future generations will bear in the form of debt retirement. Unlike responsible nations, we have, in fact, forgotten about the stakes of our children who will inherit a more distorted economic system.
While the external debt had already touched almost $60 billion by the end of last fiscal year, it was the domestic debt that started to haunt us more. The manner, in which the domestic debt was being raised, ended up creating immediate and medium-term miseries for the common man in the form of high inflation and deterioration of exchange rate.
How did we land into this debt crisis? The revival of debt in Pakistan, in fact, started from the policies adopted by the previous government in its last days and continued by the present government. First, in 2007, the global oil price hike had led to ballooning of import bill. Second, mismanagement of local food stocks forced Pakistan to import food at a time when global food prices were at an all-time high. Third, the coming of global financing crisis saw bilateral development partners (whose governments were under fiscal stress) backing out on their commitments made earlier. While the direct impact of the third channel was not felt immediately given already reduced aid inflows in Pakistan, the failure to pass on, or adjust prudently the food and fuel prices led to deterioration of fiscal deficit. The previous and present government continued to subsidise through heavily borrowing from the central bank, which in turn was forced to create superficial money.
However, this was not a one-off action as the present government during the next couple of months continued to borrow heavily from the banking system (including commercial banks). This time the borrowing requirement was not only to meet short-term liquidity requirements but also to sustain the losses of inefficient public sector enterprises. These actions, while suppressing the credit supply to the private sector, maintained a downward pressure on overall economic growth.
How to manage the debt burden? Sadly the management of debt will not be possible only through setting up of a powerless Debt Management Unit in the Finance Division. This division publishes after long gaps a debt policy statement, which is a requirement under the already violated Fiscal Responsible and Debt Limitation Act, however experts believe that this statement hardly says what an actual debt policy should illustrate. In fact it proposes fire-fighting with in the business-as-usual milieu.
There are two main concerns when it comes to management of debt. First, one needs to address the manner in which the servicing of debt should take place. Currently the servicing of debt (mainly domestic) eats away over 30 percent of the government's total revenues. With the debt overhang increasing, these servicing costs are bound to increase, as new debt will be procured on more expensive terms, given the low credit rating of the government. If defence expenditures are also added to the debt servicing costs, then these two burdens together cost to the country over 50 percent of the revenues. Such a scenario leaves behind little to sustain the development goals of federal and provincial governments.
A business-as-usual answer to this problem and to ensure that Pakistan will be able to service its past, present and future debt is to recommend widening of the tax net and expansion of tax base. However these measures do not work without ensuring improvement in the tax administration and documentation of economy. As a result, subsequent governments have continued to burden the existing sectors without exhibiting any substantial will to remove distortions in the tax system and imbalance of inter-sectoral incidence.
Another advice added to this business-as-usual answer is that federal and provincial governments should adhere to strict austerity plans, which should include their own expenditure check. Unfortunately, however, the current system of expenditure management in the federal government, 'Medium-term Budgetary Framework' is not a binding on the line ministries. While federal secretaries do report the forecasted expenditures (sometimes keeping in view the austerity measures) there is no effective monitoring and evaluation mechanism to check how strongly they stick to their own forecasts. In fact an economic justification for overshooting is rarely submitted when demand for supplementary grant is filed. The pursuit of transparent accountability rules and results based management is still a dream in waiting.
While some short-term revenue increase is possible through ad hoc tax reforms, which in turn, may improve debt servicing sustainability, expecting the tax-to-GDP ratio to expand to regional average, creating fiscal space for developing expenditures and ensuring timely disposal of debt overhang, will require deeper reforms for stimulating economic growth. Taxation only seems fair when growth is being experienced in key productive sectors of the economy.
The revival of growth will require addressing irritants such as the energy crisis in the short run and putting in place a strong agenda for structural reforms in the long run. These reforms should start with corrective measures in the government's own administrative machinery (civil service) and should be followed by reforms for competition in domestic markets (across all sectors). Given the low public sector development expenditure, the private sector can only assume a leading role in promoting economic growth if regulatory and trade related barriers to entry, operate and exit are removed.
Currently, the Doing Business 2012 data disseminated by the World Bank ranks Pakistan (out of 183 countries), at 125 in registering of property, 158 in payment of taxes, 154 in enforcement of contracts, 166 in getting electricity and 104 in dealing with construction permits. If business-as-usual is allowed to continue without substantial reforms for economic growth, pressure on the banking system will continue to mount. The widening fiscal deficit (for which the stage is set after abandoning of IMF agreement) will put pressure on consumer prices as well as exchange rate in turn making existing and future debt liabilities more expensive.
(The writer is a Research Fellow and Head of Economic Growth Unit at Sustainable Development Policy Institute.)
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