Fiscal Policy and Debt Management in Pakistan

Q#)   Major Problem with Fiscal Policy and Debt Management in Pakistan.

 

Fiscal Policy and its Problems

Fiscal policy is the use of government spending and taxation to influence the economy. When the government decides on the goods and services it purchases, the transfer payments it distributes, or the taxes it collects, it is engaging in fiscal policy. The primary economic impact of any change in the government budget is felt by particular groups—a tax cut for families with children, for example, raises their disposable income. Discussions of fiscal policy, however, generally focus on the effect of changes in the government budget on the overall economy. Although changes in taxes or spending that are “revenue neutral” may be construed as fiscal policy—and may affect the aggregate level of output by changing the incentives that firms or individuals face—the term “fiscal policy” is usually used to describe the effect on the aggregate economy of the overall levels of spending and taxation, and more particularly, the gap between them.

Pakistan’s fiscal profligacy has been in the news for the last five years. All those who have an interest in Pakistan’s economy have been writing on this issue and highlighting the importance of fiscal discipline in preventing macroeconomic imbalances as well as achieving a full growth potential. The government, on the other hand, appears to be least interested in pursuing a sound and disciplined fiscal policy. Hence, the rot continues in terms of low economic growth, stagnating job creation, increased poverty, higherinflation and more debt.

Every government typically aims at promoting strong and sustainable economic growth with a view to creating employment opportunities and lasting poverty reduction. This must probably be achieved by pursing a sound and disciplined fiscal policy. This fact may not be known to the political leadership, but it is assumed that the economic team of every government knows the importance of fiscal discipline for the economy. If the economic team members do their job honestly and urge their political leadership to pursue a disciplined fiscal policy, things would move differently.

A rule-based fiscal policy has generally been associated with improved fiscal performance and debt sustainability. Over the past several decades, there has been increasing acceptance worldwide that fiscal discipline over a prolonged period is essential for maintaining macroeconomic stability. There also exists a general consensus that a prolonged commitment to fiscal discipline can only come from a rule-based fiscal policy. Fiscal rules basically represent constraints, and prevent the government from taking a fiscally irresponsible route.

International experience suggests that countries, which have adopted well-designed fiscal rules and implemented them effectively, have garnered important credibility gains, greater electoral support, and achieved higher economic growth on a sustained basis. Fiscal rules aim to prevent governments from taking short-sighted measures in the light of election cycles and competing demands from special interest groups, by binding policymakers to a fiscally prudent path.

Pakistan has experienced serious macroeconomic imbalances in the 1990s mainly on account of its fiscal profligacy (budget deficit as percentage of the GDP has averaged almost 7.0 percent per annum), and has accordingly paid a heavy price in terms of slower economic growth, rising debt burden, and the rise in poverty. It is against this backdrop that work on a rule-based fiscal policy was initiated in 2001-02. After one year of hard work and wide-ranging consultation in all the four provinces, a rule-based fiscal framework was prepared in 2002-03. This framework was enshrined in the Fiscal Responsibility and Debt Limitation (FRDL) Act 2005, and was passed by parliament in June 2005.

The purpose of the Act was to inject fiscal discipline in the country. This Act ensures responsible and accountable fiscal management by all governments, the present and the future, and would encourage informed public debate about fiscal policy. It requires the government to be transparent about its short and long-term fiscal intentions and imposes high standards of fiscal disclosure.

There are five key elements of the law. Firstly, beginning from July 2003 (2003-04), Pakistan’s public debt would not be more than 60 percent of the GDP by end June 2013 (2012-13). In other words, Pakistan’s public debt had to be reduced from 75 percent to 60 percent of the GDP in ten years. Secondly, every year the government would reduce public debt by at least 2.5 percentage points of the GDP during the ten year period. Thirdly, revenue deficit (total revenue minus total current expenditure) would be eliminated by 2007-08 and a surplus would be maintained thereafter. Fourthly, the government would not provide guarantee to the borrowings of the Public Sector Enterprises (PSEs) by more than two percentage points of the GDP in a given year. Fifthly, social sector and poverty-related expenditures would not be less than 4.5 percent of the GDP for any given year, and the expenditure on education and health would be doubled in terms of percentage of the GDP in ten years.

As can be seen from the above, the law binds the government to pursue a sound and disciplined fiscal policy. It binds the government to reduce public debt to a sustainable level, reduce the country’s debt burden every year, mobilize resources at least to the extent of its current expenditure, prevent the government to cut social sector and poverty-related expenditures and double education and health budgets. It also forces the government not to provide guarantee to the borrowings of the rotten PSEs to prevent the growth of contingent liabilities.

A high-level debt policy coordination office was established in the ministry of finance. Besides many other functions, the debt office was made the secretariat to monitor the performance of the law. Every year, before January 31, the debt office prepares two reports – the fiscal policy statement and debt policy statement and submits them to parliament under Section 6 and 7 of the Act, respectively. While analyzing the developments on the fiscal and debt front in a year, the reports also give a compliance report of the Act. Some 500 copies of each report are submitted to the National Assembly and Senate Secretariat for distribution to the members.

From 2003-04 to 2006-07, the law performed very well. Public debt declined from 75 percent to 55 percent of the GDP during the period. However, most of the critical elements of the law have been violated in the last four years. In particular, public debt, instead of declining, has increased to 60 percent of the GDP and revenue deficit continues to prevail. None of the members of parliament has ever raised the issue of violation in the House; hence, no debate has taken place in parliament. Nobody bothers and nobody cares about the law and hence, Pakistan’s economy continues to create pain and misery for the hapless millions.

Pakistan’s Debt:

Foreign Debt is the major problem of Pakistan's Economy. Economy of Pakistan is in worst shape with growth rate lowest in the region. Although there are many problems of Pakistan's economy but foreign debt and debt servicing is an important problem of ailing economy. It becomes impossible for Pakistan to pay foreign debts servicing or interest on foreign debts without taking more debts.

On October 2010 State Bank of Pakistan reported that country had to pay $1.669 billion as debt servicing (interest) during the first quarter of fiscal year 2010-11. Size of the debt servicing increased by over 49% compared to the debt servicing made during the same period of last year. The country paid $1.193 billion as debt servicing in the first quarter of last fiscal.

In 2008 financial crises developed in Pakistan and foreign exchange reserves almost finished due to high price of oil. At that time country had to borrow loan from IMF. The IMF agreed for $11.3 billion but attached harsh conditions for reforming the economy. Now the country's ability to pay off external debt is doubtful as any uncertainty in oil prices could erode the entire reserves.

Pakistan had to pay a total $5.641 billion as debt serving in the fiscal year 2009-10, which accounts for almost more than 33% of the entire foreign exchange reserves of country. The total foreign debt and liabilities of Pakistan has reached $58.512 billion, while it was just $47 billion a couple of years ago.

Another problem is oil prices for Pakistan. Now there is acute energy crisis in Pakistan and Pakistan depends upon the oil powered or thermal power station for the generation of electricity. If oil prices again raise it will cost Pakistan more money and there are chances that reserves will erode more quickly.

The shortfall in balance of trade was more than $11.4 billion during last year, which kept pressure on external payments. Despite $8.9 billion remittances sent by the overseas Pakistanis, the country had to face current account deficit last year. Pakistan’s long-run debt-servicing capacity is extremely low, primarily due to low savings and productivity. It is further observed that with the current state of savings and productivity, Pakistan has to choose between sacrificing growth and prolonging the unsustainable position of continuously growing debt burden.

How to pay back debt:

The problem with Pakistan is that although it has internal resources to bridge the budgetary gap but tax collection system in Pakistan is worst in the world and tax to GDP ratio in Pakistan is not only lowest in the region but lowest in the world. There is only one way to get out of this vicious circle of debt and that is to generate enough income from internal resources to pay off the debt servicing and debts. For this purpose government has to increase its tax net and especially the wealthy people in Pakistan are not paying taxes. If government fails to generate income from indigenous resources then they have to take more loans to pay previous loans.

Problems of Balance of Payment deficit and depleting foreign exchange reserves can be overcome by buying foreign exchange from overseas Pakistani workers rather than accumulating foreign loans on tough terms. Cost of this purchase is far less than the interest paid on foreign loans and involves no repayment of principal.

Overseas workers remittance in real terms is almost equal to entire exports of Pakistan. If re-routed from Hawala to Banking Channels, it has the potential to convert the Balance of Payments to surplus, increase our Forex reserves, avoid taking further foreign loans and payoff Pakistan’s foreign debt in real terms through our own sources. Total cost to the Government at present exchange rate shall amount to 2.25% in the form of incentives to banks and remitters. This shall be the cost of buying USD from overseas workers. It still will be far less than interest paid on the IMF loans of around 4 % p.a. repayable in USD. In addition, the obvious advantage is that there is no repayment of principal amount. Hence, no exchange rate risk involved at the time of repayment as well. All these payments by government in the form of incentives will remain in Pakistan’s economy, (unlike loan installments to IMF, which are outflows from our economy). The part that will go to overseas Pakistanis will be distributed among their families in Pakistan, hence will have a positive impact in the form of increase in per capita income, which will be further circulated in local economy, effecting employment growth and increase in revenue generation for national exchequer. The remaining amount paid to banks in the form of commission will go towards meeting the cost of developing systems, resources, network growth, advertisement, etc. The overall effect of growth and profitability of the local banks will lead to strengthening of our financial sector, increase in employment and improvement in revenue generation for national exchequer. This shall also help in curbing smuggling and under-invoicing, as cost of un-official outward remittances through Hawala will go up.

Pakistan must improve its saving rate by continuing and even further refining the ongoing process or tax reforms, downsizing of the public sector and privatization of public sector enterprises. Pakistan needs to improve its overall productivity in the economy, especially in the public sector. The privatization process needs to be accelerated for the sake of minimizing the cost of losses in the public sector and improving productivity rather than revenue generation. Pakistan also needs to manage its debt in a better way. There is utmost need for enrichment of the intellectual capacity in the public sector institutions responsible for debt management. These institutions also need to be reformed thoroughly and given sufficient autonomy.

Pakistan has to be selective in choosing among the alternative aid and loan packages. External borrowing has to be target specific and the targets have to be specified in the light of a social welfare function that assigns due weight to social as well as economic considerations such as growth enhancement, promotion of equity and social justice and eradication of poverty. External borrowing must be undertaken within the framework of economic plans rather than making the planning exercise contingent on the availability of external resources.

Posted in: Fiscal Policy and Debt Management in Pakistan.