The combined borrowing from external sources by the government, public sector enterprises banks and the private sector reached the, more or less, unbelievable level of almost $16 billion in one year, 2016-17. Not so long ago, this used be the cumulative borrowing over a two to three year period. The total outstanding external debt now stands at above $ 83 billion. The bulk is public external debt at $ 66 billion.
What were the sources of the large Government external borrowing in 2016-17? First, traditional multilateral agencies like the IBRD, IDA and ADB provided, more or less, concessional long-term financing of almost $3 billion. Second, bilaterals, especially member countries of the Paris Club, gave assistance of close to $5 billion. Third, China emerged as a major financier with project assistance of $1.6 billion and most of the financing by its commercial banks. The overall commercial borrowing by the Government was almost $5 billion in 2016-17. Also, $1 billion was obtained by flotation of a Sukuk bond.
The other three borrowers collectively obtained loans of $5 billion largely also from commercial sources. For the first time, local commercial banks went in for big market borrowing internationally, mostly short term, of over $3 billion.
How was this large amount used? Over $6.5 billion went to the repayment due of outstanding debt. Consequently, $10 billion was left for other purposes. However, all of it was used to finance the huge current deficit of over $12 billion in the year. In addition, foreign exchange reserves were depleted by $2 billion to cover the remainder of the current account deficit.
This explosion in borrowing internationally in 2016-17 comes on the back of relatively large external financing in recent years. During the four years of the PML(N) government the total cumulative overall gross external borrowing is an unprecedented $42.6 billion. This includes $6.2 billion from the Extended Fund Facility of the IMF. Repayment of this loan has commenced in 2017-18. Net of debt repayment, the total net external borrowing by the incumbent government is $22.2 billion. During the first three years it was used primarily to build foreign exchange reserves. However, as highlighted above, external loans have been used totally to finance the current account deficit in 2016-17. In the absence of this borrowing, reserves would have fallen more precipitously as compared to the actual decline of $2 billion.
The large inflow of borrowing since 2013-14 has contributed to a fundamental problem called the 'Dutch Disease'. This happens when large external inflows lead to artificial stability in the exchange rate. This results in a loss of competitiveness of exports and reduces the capacity to service future debt obligations. Pakistan's experience over the last four years clearly demonstrates the existence of this problem. The perverse outcome is that it has simultaneously reduced the sustainability of the external debt, with lower exports.
The desperation to preserve foreign reserves is vividly demonstrated by what happened in the last quarter of 2016-17. Reserves had started declining from October 2016 onwards. They were rapidly falling to a level below that required to provide import cover of at least three months. Consequently, in the last quarter loans were obtained by the Government urgently of the magnitude of over $5 billion, equivalent to as much as half of the annual borrowing. This required that more funds also be mobilized from international commercial banks, mostly of China. The result was relatively short-term commercial borrowing at market rates of interest amounting to almost $2 billion in the last quarter.
The conventional approach to determining the sustainability of external debt is to gauge the rise in key financial ratios. The first is the external debt to GDP ratio. It was 27.1 percent in 2007-08, falling to 21.3 percent in 2012-13 and attaining a peak of 27.3 percent in 2016-17. The second ratio is that of the size of external debt to exports. This was 242 percent in 2007-08, rising to 257 percent in 2012-13 and then jumping up sharply to 383 percent in 2016-17. The Debt Policy Statement of the Ministry of Finance derives these ratios only for public external debt. However, it needs to be appreciated that the debt repayment obligations of the private sector, public sector enterprises, etc., have also to be met from the foreign exchange reserves of the country.
The ultimate litmus test of the sustainability of external debt is if the repayment of the outstanding debt can be financed without drawing on the foreign exchange reserves. This has already happened in 2016-17. In the ongoing year, as of the end of the third week of September 2017, the reserves stand at $14.1 billion after a fall of over $2 billion, barely enough to cover three months imports. This decline in less than three months is equivalent to the fall over the whole year of 2016-17.
As such, what is the likely outcome in 2017-18? The Federal Budget documents for the year project net external borrowing of $ 5 billion during the year. This includes the flotation of a Sukuk bond of $1 billion and continued resort to international commercial banks. There has been a delay in issuing the bond. It should have happened immediately after the commencement of 2017-18 when the level of reserves was significantly higher and Pakistan seemed to be more credit worthy. Further delays increase the risk of under-subscription in the bond or a visibly higher interest rate.
The big question is the likely size of the current deficit in 2017-18. Already, in the first two months it has doubled. A few days ago in its update of the Asian Development Outlook, the ADB has projected that it will rise to above $14 billion, representing a growth of 17 percent over last year's level. This is still a conservative projection and the way things are going the current account deficit could approach $16 billion in 2017-18.
The financing gap is likely to be as much as $11 billion. About $3 billion could be financed by non-debt creating inflows, like FDI, leaving a gap of $8 billion to be met by a drawdown of foreign exchange reserves. As such, by 30th June 2018, they could fall to about $8 billion, not even adequate to cover two months of imports. This process of decline will further affect Pakistan's credit worthiness. Already, the IBRD has shown some reluctance to advancing more credit to Pakistan. The big question is will Chinese Banks bail us out once again as they did in 2016-17? Alternatively, will we go back to the IMF for another loan facility, less than two years after the end of the last EFF?
What is the outlook beyond 2017-18? In 2018-19, larger repayment of $500 million will have to be made to the IMF. A balloon payment will be required of $1 billion following maturity of the Sukuk bond floated in 2013-14. Also, many of the commercial loans will also need to be retired. In addition, oil prices are on the rise and could go up by over 25 percent within the next one year. As the power plants come on line there will also be need for more fuel imports.
Altogether, the country is moving into a period of great financial difficulties. Currently the Government's energies are directed elsewhere. This must change, more or less, immediately. Emphasizing once again, strong and broad-based set of measures need to be put together and implemented soon to boost exports and reduce imports so as to bring down the current account deficit to a manageable level and prevent a drastic draw dawn of reserves.
(The writer is Professor Emeritus and former Federal Minister)
Comments
Comments are closed.