Pakistan’s external debt repayment problem is attracting more attention than the base problem of rapidly increasing external debt itself.
During the last decade FY13-FY22, Pakistan’s external debt and liabilities (loan stock) have doubled from $65 billion (Jun-2012) to $130 billion (Jun-2022), growing at a Compound Annual Growth Rate (CAGR) of 7.1%. Comparatively, the economy has expanded at a CAGR of 4.5% only.
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As the economy grows, the loan stock also grows in tandem, in absolute terms, in order to support a larger size economy. If both the economy and the loan stock grow at the same pace, their ratio will remain constant.
However, this has not been the case.
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In just the past 10 years, the debt to GDP ratio has aggravated from 30.9% (June 2012) to 39.7% (June 2022), increasing disproportionally by 88 basis points every year. This mismatch has already caused external debt servicing to grow beyond repayment capacity.
External trade has always been in an imbalance resulting in a current account deficit (CAD) almost every year despite increasing workers’ remittances. Foreign Direct Investment (FDI) remains low, and the balance is met by incurring external debt and liabilities. During the last decade, the country has incurred a CAD of $83 billion, and almost all of it is funded by debt.
For Pakistan’s economy, a limited current account deficit acknowledges the fact that the trade balance cannot improve in a short time and that investment is required to be made for bolstering the capacity for export and import substitution.
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Recognising the importance of building capacity, successive governments introduced schemes in order to incentivize investors. Among them, Long-Term Financing for Export-Oriented Projects (LTF-EOP/LTFF) in 2006/07, China Pakistan Economic Corridor (CPEC) in 2015 and Temporary Economic Refinance Facility (TERF) in 2021.
But all these schemes preceded a ballooning current account deficit in the following years when the consequent demand for the import of plant and machinery was competing with the demand of other imports. This situation was not considered in the planning, as no simultaneous action was taken to slow down demand for non-essential imports to recognize that the space in the current account is limited. As a result, growth was borrowed from the future.
Ignoring these imbalances for many years has eventually led to a point where the problem of external debt servicing is to be dealt with in a firefighting mode. Imports are halted, businesses are suffering, and industries are facing shortage of input materials.
To stop worsening of debt to GDP ratio, a further annual ceiling need to be introduced, and all policies should be integrated backwards. Despite the ceiling, the space for growth will still be available. At the end of FY22, the size of GDP was $328 billion and loan stock stood at $130 billion. Since the economy has grown at a CAGR of 4.5% in the past decade, loan stock can also grow at same pace while remaining within the ceiling.
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For example, a $5.8-billion addition in loans (4.5% of $130 billion) would have kept the debt to GDP ratio constant for FY23. Considering average FDI of $1.7 billion, we arrive at a sustainable current account deficit of $7.5 billion or 2.3% of GDP.
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While the present political and economic crisis is taking time to settle, the financing sources have dried up. During the first nine months of FY23, the disbursement of fresh external loan is lagging the loan repayments being made. The overall debt and liabilities have therefore reduced from $130 billion (Jun 2022) to $126 billion (Mar 2023).
The sudden drop in loan stock is unsustainable due to the pain it is causing to the economy. The loan stock will start rising again as soon as the lenders are satisfied, but internally a policy and plan must be made and followed recognizing the capacity to run a current account deficit, in order to avoid a similar situation in the future.
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