Growth in external debt

The external debt of Pakistan stands at $113.8 billion as of the end of September 2020. It has registered an increase of only $0.9 billion in this quarter. Therefore, there are indications that the pace of accumulation of external debt has slowed down. During the corresponding quarter of 2019-20 it was also relatively small at 0.8 billion.

The historical growth path of external debt has been variable one. At the end of the Musharraf Government in 2007-08, total external debt and liabilities stood at $45.4 billion. During the tenure of the PPP Government it increased to $60.9 billion, with an annual rate of increase of 6 percent.

The emergence of large current account deficits in the external balance of payments during the last three years of the PML(N) Government greatly increased the need for external borrowing to finance the deficit. Consequently, the total external debt rose to $95.2 billion, with an annual growth rate of 9 percent.

The PTI Government targeted for a big decrease in the current account deficit from the peak of $20 billion in 2017-18. Much success has been achieved and two years later the deficit has been brought down to only $3 billion.

However, it is perhaps surprising that the external debt has continued to grow at the rate of 9 percent and increase from $95.2 billion in June 2018 to $112.9 billion by June 2020. Some of the borrowing has been used not only to finance the current account deficit but also for building up foreign exchange reserves. These have increased from $9.8 billion in June 2018 to $12.7 billion by end June 2020. Currently, they stand at $12.7 billion as of the 7th of November 2020.

Various measures have been used to quantify the external debt burden on a country. The most commonly used indicator is the ratio of the external debt to the GDP (in $) of a country. In the case of Pakistan, it was 27.7 percent of the GDP in 2007-08. Over the next five years, up to 2012-13, it actually declined to 27 percent. Thereafter, by 2017-18 it had risen sharply to 33.4 percent of the GDP. However, the rise has been ever pronounced since then. In two years, it has increased to 45.5 percent of the GDP, implying a rapid jump by over 12 percent of the GDP. This is mostly because GDP, the denominator in the ratio, has decreased by over 16 percent. The big devaluation of the rupee from mid-2018 onwards has contracted the GDP in dollar terms.

Another indicator of the external debt burden is the ratio with respect to exports. This ratio was 223 percent in 2007-08, 246 percent in 2012-13 and 384 percent in 2017-18. By 2019-20 it has risen further to 502 percent. This magnitude for Pakistan is very high compared to other South Asian countries. It is 84 percent in the case of Bangladesh, 102 percent in India and 250 percent in Sri Lanka. Clearly, this implies that Pakistan will have greater difficulty in servicing its debt repayment obligations.

A somewhat unconventional measure, but which is more direct, is proposed. This is the ratio of the annual external debt repayment to the foreign exchange reserves. In the case of Pakistan, it was as low as 17 percent in 2015-16. Since then it has mushroomed to 80.2 percent by 2019-20. Clearly, the pressure on foreign exchange reserves of external debt repayment has increased substantially. It will not be surprising if the ratio approaches 100 percent in 2020-21.

Turning to the composition of external debt, there have also been substantial changes since 2007-08. Bulk of the Government debt had historically been in the form of long-term low cost borrowing from bilaterals, especially the Paris Club countries, and from multilateral agencies like the World Bank, Asian Development Bank and the Islamic Development Bank. The share of these lenders in the total external debt of Government was almost 88 percent in 2007-08.

Increasingly, there has been greater resort to medium-term and commercial sources of finance including international commercial banks, especially of China, flotation of Euro/Sukuk Bonds, funds from the IMF deposits by central banks of other countries like China, Saudi Arabia and UAE and of SWAP funds. Consequently, the share in outstanding external debt of traditional donors has fallen to 51 percent.

The impact has been a rise in the interest cost and rate of maturity of external debt. The interest cost was 1.4 percent of the debt, at the end of the previous year, in 2012-13. It has now risen to 3.0 percent in 2019-20. Similarly, the ratio of debt repayment to outstanding debt has doubled from 4.2 percent in 2007-08 to 8.5 percent in 2019-20.

The inevitable implication is that the ratio of net borrowing, after repayment of debt, to gross borrowing has decreased sharply. It has declined from over 80 percent to only 25 percent since 2007-08. In effect, if the target level of financing of the current account deficit, net of non-debt creating inflows, is $4 billion then the gross level of borrowing will have to be as much as $16 billion with external debt repayment of $12 billion.

This is the outlook for Pakistan's economy in 2020-21. Although there has been a surplus in the current account in the first quarter, imports are likely to rise as the economy recovers. Due to shortages, there will be additional imports of agricultural products of over $2.5 billion. Also, oil prices have started rising and could add another $1 billion to the import bill by June 2021.

Therefore, the likelihood is that the current account deficit could approach $6 billion in 2020-21. The IMF expects it to be above $6.5 billion. Net non-debt creating inflows like foreign direct investment and equity inflows are unlikely to exceed $2 billion. Therefore, the net financing requirement is $4 billion.

The resulting estimate of the required gross level of borrowing is $16 billion as the debt repayment is likely to be close to $12 billion. The fundamental question is whether such a high level of financing can be arranged from the diverse set of sources.

The problem is likely to be compounded by the absence of an operational IMF program. In the absence of this umbrella, risk perceptions of lending to Pakistan are likely to be very high. $3.5 billion worth of loans have been given to Pakistan by the multilaterals and by the continued support of China in first quarter of 2020-21. There will be need for an additional financing of $12.5 billion over the next three quarters of 2020-21. There is the likelihood of an attempt at flotation of Euro/Sukuk bonds shortly of up to $2 billion.

We hope that the Government is able to organize successfully the required level of external financing at a time when the country is going through a period of severe 'stagflation' with concomitant higher unemployment and poverty and there is a movement launched by the political opposition.

(The writer is Professor Emeritus at BNU and former Federal Minister).

Copyright Business Recorder, 2020