Lately, a few commentators have been talking on public debt, and the narrative is populist. In economics, absolute numbers over span of decades have no meanings. For instance, public debt grew from Rs3.2 trillion in 2000 to Rs32.7 trillion in 2019. Terming it a catastrophe by translating it to per capita is incorrect.
One has to look it in terms of GDP – which grew from Rs4.2 trillion to Rs38.6 trillion in the same time – almost 10 times. The capacity to absorb debt also increased 10 times. Think of a person earning Rs10K per month in 2000 and if now he is earning Rs500k – his ability to take debt has increased by 50 times – he can afford a good car, good schooling for kids and a nice cozy vacation.
The second mistake some are making is converting the foreign debt in domestic currency. The basic economics and perhaps common sense is that foreign debt has to be paid in foreign currency and that has to be financed by foreign reserves. The SBP cannot print dollars. Stop calculating foreign debt in rupees. It is wrong and confusing.
Prior to 2000s, Pakistan was heading for an external debt trap and then rescheduling of Paris Club. The crisis was averted in Musharraf era–foreign public debt declined from 50.9 percent of GDP in 1999 to 23.4 percent in 2007. The domestic debt also fell from 47.4 percent to 28.3 percent in the same time – overall public debt fell from 98.3 percent to 51.6 percent.
Thereafter, the story is not that rosy. Higher fiscal spending and all resulted in increase in debt from 51.6 percent of GDP in 2007 to 70.4 percent in 2018. The foreign debt was declining and reached a low of 17.4 percent in 2015 before inching up to 22.7 percent in 2018 – and it started increasing in 2015 to finance the growing current account deficit.
The thorny issue was of growing domestic debt – which increased from 28.3 percent of GDP in 2007 to 47.8 percent in 2018 (it grew further in 2019 and that was bound to happen as FY19 budget was designed to have higher deficit). The SBP can print rupees; and it did. Government borrowing from SBP increased from Rs1.2 trillion (9.1% of GDP) in 2009 to Rs3.6 trillion (10.4% of GDP) in 2018 and add around Rs2 trillion of reverse OMO (commercial banks’ refinancing to government on 50 bps spread over borrowing from SBP) to make its Rs5.6 trillion (16.2% of GDP). The number increased to Rs6.7 trillion (17.4% of GDP) in 2019. This partially explains where inflation is coming from.
The consequential problem is higher domestic debt reliance on banking system – both SBP and commercial banks, is crowding out of the private credit. It peaked at 27 percent of GDP in 2007 when domestic debt was at its lowest ebb (28.3% of GDP). Thereafter, domestic public debt increased to 47.8 percent of GDP in 2018, and private credit fell to 17 percent of GDP. The interesting point is that real interest rates remained lower than historic average in this time, but private credit (investment) fell. Hence, lowering domestic public debt can create space for private credit to grow up, irrespective of interest rates.
The point of concern for many is debt has increased substantially in 2019 – both domestic and foreign public debt increased in terms of GDP – from 47.7 percent to 53.8 percent and 22.6 percent to 28.1 percent, respectively.
The reason for increase in public debt is higher fiscal deficit of Rs3.44 trillion in 2019 (FY19). The government domestic debt in absolute terms increased by Rs4.3 trillion and adjusting to additional cash balance of government with banks, the net increase in debt is Rs3.3 trillion. In case of external public debt, it increased from $75.4 billion to $84.0 billion.
One may wonder when domestic debt is almost covering the fiscal deficit, why increase the external debt? There are some components of external debt which are for balance of payment support only as the reserves were getting low and reserve building was required for stability. The central bank deposits – not for fiscal use, increased from $700 million in Jun-18 to $6.2 billion in Jun-19. That is what Pakistan got from friendly countries last year, before the IMF programme.
The external debt, net of foreign exchange liabilities, increased by $2.9 billion and converting into rupees at average exchange rate of FY19 of 136.4, the number is estimated at Rs392 billion. The total debt –domestic and foreign, adjusting to foreign exchange liabilities and increase in cash balance, is around Rs3.76 trillion versus Rs3.44 trillion of fiscal deficit – MoF needs to explain about rest of Rs319 billion, but that is a much smaller number in context.
So the sudden rise in debt in FY19 is explained as majority of foreign debt is for balance of payment support, and around Rs1.3 trillion of SBP domestic debt taken in Jun-19 has been kept as excess cash to create buffer. That is why the debt numbers are falling from Jun-19 to Sep-19 – from 81.2 percent of GDP to 75.6 percent of GDP (foreign debt- from 28.1% to 24.1%, and domestic debt from 53.7% to 51.5%).
Now on the question why Pakistan needed higher foreign debt in FY19 and why higher fiscal deficit was in the same period. For fiscal deficit – read “reported fiscal deficit – not too scary”. One needs to see the total external scorecard for it –the change in foreign reserves of the country minus total external debt and liabilities increase.
The problem started right after exiting IMF (Oct-16) as the current account deficit started ballooning. For simplicity, let’s evaluate what happened between Jan17-Jun18 – the country’s total external debt and liabilities increased by $19.5 billion and total foreign reserves fell by $6.8 billion – total external scorecard dipped by $26.3 billion. The commutative current account deficit in that period was $27.8 billion.
The horror story continued. The new government did not have a magic wand to stop the current account bleeding immediately. The current account deficit in FY19 was $13.8 billion and the external scorecard was minus $13.0 billion – external debt increased by $11.1 billion and reserves were down by $1.9 billion. Now you may understand why external debt kept on growing in FY19. Converting into rupees and making headlines or attracting retweets is unfortunate.
FY20 (Jul-19 to Sep-19) is changing direction for betterment. The fiscal deficit is low at Rs286 billion – low growth in debt. The other element is that there is sharp reduction in current account deficit – for the first time in 1QFY20 since 2QFY15, the change in reserves minus debt increase (external scorecard) is positive – at $209 million.
Lower fiscal deficit will help reduce the need of overall debt, and better current account number will yield better external scorecard. The next question is why is there a need to build foreign debt. That is to create space for private credit and that can only enhance when there is less reliance of government borrowing on domestic banking system, irrespective of interest rates. The good sign is that government domestic debt, net of cash balances, increased by mere Rs240 billion in Jul-Sep and the foreign debt is growing. With portfolio investment pouring in government debt, eventually banks have to find borrowers in private sector. Wait for six months, when the interest rates start coming down, see the magic of ‘crowding-in’.