Debt management must also respect demands of monetary policy

The shift in debt mix towards foreign currency liabilities at the time of stagnation in export revenues is a point of serious concern for the balance-of-payment solvency.
On the other hand, despite recent efforts to create domestic debt capital market, the limitation on high powered money creation at the time of rigid expenditure on war and debt servicing is not only threatening fiscal solvency, but also crowding out the private sector.
The increase in marginal propensity to consume by five percentage points to 79 percent in the period of economic boom, rendered domestic savings insufficient to fill the requisite gaps during the past many years. Now, the problem has exacerbated at the time of stagnating disposable income.
"Prudent debt management is more of an art than science," the Finance Ministry said in its recently issued debt policy statement. The rise in foreign currency public debt constituted 63 percent of the net increase in total public debt during fiscal year 2009.
The fact that around 40 percent (Rs633bn) of the public debt is due to a steep depreciation in rupee, warrants immediate attention to articulate debt policy.
Moreover, the widening gap between the open market and inter-bank currency rate is threatening the growth in home remittances that has been instrumental in salvaging the balance of payment crises of late.
"Borrowing is necessary for economic development of any country as long as the economic returns are higher than the cost of invested funds," the debt policy statement rightly pointed out.
But the ratio of total public debt to total revenues, which was reduced to 3.71 times by FY07, worsened to 4.11 times in FY09. This seriously questions the rationale of higher debt creation and the governments ability to repay the same.
The ministry aptly points out the policy inaction - energy subsidy - of previous government amid economic slowdown that caused the escalation of public debt during the last two years. But then, those economic managers had reduced the debt by 7 percentage points to 55.5 percent of GDP in the span of two years.
But instead of playing the blame game, lets focus on the current machinerys plans to curb the burgeoning debt. A closer look into numbers reveals that despite lower real growth in public debt last year (FY09: 1.7% vs. FY08:8.5%), the decline in real growth in revenues increased the debt burden.
Although, the debt service to revenue ratio declined by 2 percentage points to 43.5 percent in FY09, going forward, repayments to the IMF will increase the quantum of debt servicing. Thus, a greater amount of resources ought to be allocated for debt servicing in future, which can hinder development spending.
The apparent solution to these problems is an increase in government revenues. But given the inelastic nature of taxes, the potential to get trapped in debt is a fair possibility.
The easing of monetary policy is imperative for growth in private sector, hence taxes. This coupled with the expanded tax net and improvement in tax collection system - partly solvable by the proposed VAT - is direly needed to rescue the economy.
The high cost zero coupon domestic debt sold in the late 90s, which had ballooned domestic debt servicing lately - looks subdued ahead. These factors might help in reducing the debt a bit going forward, but the bleak security situation is unlikely to attract foreign debt so easily - whereas an increased reliance on domestic debt will deter private sector output, hence revenue growth.
Indeed, debt management is more of an art than science. How will the economic mangers eventually carve their piece, is not known yet, but its imperative to enhance the width and breadth of taxes, while controlling unnecessary expenditure and leakages.