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The Pakistan government’s spending exceeded its revenue by a whopping 70% in the year before the pandemic, highest — the absolute highest—among major developing countries worldwide. Urgently addressing the spending-revenue gap is critical. Our own history shows that it can be done.

When someone’s income falls short of their expenses, they are said to be living beyond their means. If they do so over an extended period, their debts build up quickly.

The interest on those debts becomes a major additional expense, making the excess of spending (which now includes interest payments) over income even larger. And if a calamity happens — whether a sudden loss of income or the emergence of an urgent spending need — lenders may refuse to lend further because they fear they might never be repaid. That, in turn, forces the borrower to cut expenses at the worst possible time and by more than they would have had to if they had not lived beyond their means in the first place.

The same holds true for governments. A government that spends more than it takes in through taxes and other receipts has to borrow. When borrowing (or debt) accumulates, the interest that must be paid becomes a burden and can force cuts in essential spending in order to make ends meet.

Pakistan’s government has almost always spent more than its receipts. In 2019, the last year for which comparable data for all countries are presently available, our spending exceeded our revenues by almost 70 percent. This overspending imbalance ranked highest among all major developing economies in the world.

Large imbalances year in and year out have resulted in a steady buildup in debt owed by our government. By 2019, debt amounted to almost 7 times the government’s annual revenue receipts. As debt has increased, so has the interest bill that the government has to pay on that debt—to 40 percent of the government’s revenue receipts. In other words, close to half of the revenue the government brings in has to be spent on paying interest on money borrowed to pay for past spending.

Because it uses up such a hefty share of the government’s resources, the large interest bill severely limits what the government can spend on the essential needs of its citizens such as hospitals, schools, and security. It also raises the specter of further deep cuts to the already meager amounts allocated for these essentials if financing dries up in the future. Devoting such a large share of revenue to paying interest is like skating on thin ice, so reducing this ratio must take priority.

There is no magic level below which the share of interest in government revenue is “safe” and above which it remains risky. But experience from other countries suggests that it is rare to sustain a ratio above 25 percent for an extended period. Indeed, in the decade preceding the global pandemic, only four major developing countries other than Pakistan (Egypt, Ghana, Lebanon, and Sri Lanka) reached or exceeded 40 percent. None of the other 30+ countries ever even reached 30 percent.

Engineering a large reduction of the interest bill relative to revenue is a difficult and painful task, but we need not look elsewhere to see that it can be done. Pakistan was able to reduce our interest bill from 45 percent of revenue in 2000 to 21 percent in 2006. How did we do it?

— Almost the entire drop in the ratio—22.5 of the 24 percentage points—came from an increase in government revenue, which more than doubled in six years. Adjusting for inflation, the revenue increase was about 50 percent, or about 7 percent annually in real terms.

— The government managed to prevent any increase in the interest bill. Even though the level of debt rose by 40 percent, the effective interest rate dropped from 8 percent to 5.5 percent, keeping the amount of interest paid flat. Lowering of interest rates was made possible by the achievement of low inflation (3-4 percent until 2005).

— Spending other than interest was also contained early on. The excess of total spending (including interest) over revenue was cut from 30 percent in 2000 to under 1 percent in 2003. For that one year, the government more or less lived within its means.

Of course circumstances today are very different than they were twenty years ago. Whether public support for painful spending cuts and revenue increases can be won and then sustained over several years remains to be seen. Geopolitical and geoeconomic realities are also not the same, so the level of external financing support may be weaker. Inflation is presently very high, so we are unlikely to see substantially lower interest rates soon.

There is no unique combination of specific revenue enhancements, expenditure restraints, and – eventually — interest rate cuts that is sure to do the trick. Anyone who claims there is probably has an agenda to advance. A careful study of what worked last time around could be instructive, but today’s solutions will need to fit today’s realities.

Whether any combination of measures succeeds or fails will hinge on convincing people that the burden of adjustment is being distributed fairly and broadly. The task at hand is difficult, but we have to learn to live within our means. Our future depends on it. Our own history shows that it can be done.

(The writer is a former senior staff member of the International Monetary Fund)

Copyright Business Recorder, 2022

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