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How to manage imminent debt hangover?

Globally, fast rising trend of both external and domestic debt, emerging in 2008 and onward due to economic recession has engulfed entire financial world in whirlpool of fiscal deficit both in developed and developing economies. No doubt some of the high income developing countries had taken radical measures to recapture their lost sustained economic growth rate and luckily came out of quandary. However onslaught of Covid-19 factor has drastically damaged their economies and put them in a negative growth rate situation.

Problem has however aggravated in case of low income developing countries, Pakistan in particular, where slow penetrations of after effects of global recession which apart from causing fast depletion in economic growth rate resulted in growing fiscal deficit have now dragged the country into a worst situation due to invasion of Covid-19 as such country continues to experience inflating domestic as well as external debt, currency debasement and plans to table repeated requests for restructuring of debt instead of going for default, which has been a practiced phenomenon among Latin American countries and even some Middle Eastern countries in the past. These countries have achieved a significant reduction in their external debts via restructuring and default.

Pakistan’s economy already in grip of substantial debt and in the face of recent past devastating floods and now Covid situation warrants further heavy internal as well as external borrowings leading to further worsening debt-GDP ratio as external debt and liabilities have reached US$109949 million (Rs.17591/84 billion) and after adding domestic debt of Rs.22478 billion by end of March 2020 during the same period, total debt stands at 85.97% of GDP.

On the other hand in the present scenario during fiscal year of 2019-2020 Rs.1.9 trillion going for debt servicing represent 79% of net federal receipts, which highlights adverse implications of flawed budget and monetary policy plus heavy domestic borrowings from banking sector resultant of poor governance at all tiers of government. Ailing public sector entities alone consume a subsidy exceeding Rs.350 billion, which is now planned to be reduced Rs.180 billion during the current fiscal year. Consequently fiscal and monetary discipline cannot be achieved and country is faced with a galloping inflation despite tight monetary policy ( although now eased up to some extent. Kenneth Rogoff in his book ‘This time is different’ states that inflation is a form of de-facto default on domestic debt, particularly if that inflation is coupled with financial repression. Thus country faced with similar situation is trapped in vivacious cycle of rising allocations for debt servicing, fiscal deficit and further borrowings every year. Country already owes US$76498 million to IMF apart from its liability to other funding sources like, Asian Development Bank and various multilateral funding agencies and Paris Club etc. Unfortunately due to delayed payment a sizable percentage of debt is deducted at source on account of penalties and interest etc. However, some of these funding agencies are seriously thinking of providing debt relief to developing economies including Pakistan to overcome economic losses caused by onslaught of Covid-19. Particularly Paris Club countries have suspended $1.8 billion payable by these countries in the form of principal amount and interest. These amounts would be restructured in remaining payment schedule. IMF also have plans to provide some repayment relief to Pakistan regarding its total debt outstanding.

Increasing economic and political vulnerability has forced present government to acquire more loans not only for rectifying the prevailing situation, but also to facilitate inherited quantum of external debt.

Unfortunately, despite Pakistan’s effective role in curbing terrorism all over the globe country continues to be in grey list of FATF (Financial Action Task Force) and funding agencies continue to attach more and more strings to fresh loan packages. IMF insistence on bringing major tax reforms so as to enhance tax-GDP ratio during the current fiscal year and also removing all subsidies from utility services particularly electricity etc. Further pressure from their side to increase prices of utilities particularly of electricity and gas will result in slow down of economic activity, increase in unemployment and cost of living thus nullifying the results of tax reforms planned to be undertaken.

Measures to meet debt burden

Although there has been talk of not going to IMF for further financial assistance, but in the face of devastating effects on economy of unprecedented damage done by Covid19 and also floods experienced in the recent past country has no other option except to go for default. All fears relating to default need to be shed away in view of Pakistan’s strategic importance for success of NATO forces in Afghanistan and its voluntary initiative to carry on military operations in its own territory to curb terrorism. Government must come up boldly to declare default. No doubt in this regard apprehensions of stalling further financial assistance and loans from funding agencies, but in view of global distress caused by Covid-19 sympathetic attitude is expected from all funding agencies.

Further removal of debt burden by declaring default situation will boost economic activity, initiate monetary and fiscal discipline and country would be able to attract foreign investment and rejuvenate lost trade relations. In this regard it is essential that restructuring or rescheduling of existing debt should not be acceptable. As stated above in the past even economically developed countries and high income developing countries like Russia, Latin American countries like Argentina, Brazil and Mexico have boldly taken the stand of not repaying the external loans accumulated to the extent of almost 100% of their GDP. This situation has repeatedly been experienced by Latin American countries in the past and resultantly these financial concession/remissions have helped achieving accelerating economic growth rate and total turn-around of economy.

Global financial deregulation during 1990s and capital flows from industrially rich counties to developing economies caused excessive indebtedness on the part of weak economies resulting in debt overhang in late nineties. Funding agencies particularly IMF and ADBP and also countries with whom these countries had bilateral loan seeking arrangements provided systematic debt relief through rescheduling or total write off particularly to poor countries marked with low income but commodity rich economies like sub-Saharan African countries. When commodity prices started rising with the start of new century, these countries in quest of expanding their economies borrowed heavily from emerging markets like China and thus there occurred another cycle of heavy indebtedness followed by another default scenario. Hence for Pakistan it should not be a matter of concern to go into default in the face of weak economy severely battered by Covid-19 and other natural calamities.

Paris Club countries must voluntarily come forward to write off all loans disbursed to Pakistan in addition to relief already announced by Paris Club countries regarding repayment of existing loans.

Since Pakistan is an ally to NATO to which all Paris Club countries are members and are busy in gaining control of Afghan Taliban through reconciliation strategy, they in view of Pakistan’s major role in facilitating their reconciliatory efforts to arrest the activities of Taliban all over the globe, they must come forward to the rescue of Pakistan’s government to get rid of mounting external debt.

Apart from management of external debt, it is essential that fiscal discipline be strictly observed. For that government borrowings from banking sector be drastically cut down by controlling non-developmental expenditures, for which size of all cabinets and all administrative expenses including remunerations and perks of legislators be reduced by 50% and travel expenses at all levels be strictly monitored to prevent waste of country’s resources.

It is high time that tax net be extended to agriculture sector also. To begin with farmers having annual income exceeding Rs1.5 million are brought under tax net. After flood affected population is properly rehabilitated and farm activity boosts up then small farmers having farms above subsistence level of 25 acres be also made liable to pay income tax.

Apart from asking for loan remissions/write offs government need to demand greater economic access to NATO countries markets particularly USA.

To arrest unbridled growth in domestic debt government has once again started to rely only on long and medium term government securities like Pakistan Investment Bonds and National Saving schemes. The debt burden and its cost is likely to reduce substantially after government’s very recent success in issuing long term bonds at interest rate well below policy rate.

Further to help Islamic banking institutions to manage their liquidity government has started issuance of 5 years floating rate Sukuks. Similar initiatives must continue to bring in monetary and fiscal discipline so as to improve debt profile of the country.

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