by Dr. Ashfaque H. Khan
The author is Principal and Dean of NUST School of Social Sciences and Humanities, Islamabad
The readers would recall that I wrote an extensive article under the title of “Rising Debt: A Threat to National Security”, published in this Quarterly during January – March 2016 issue. This article generated considerable interest among economists and others with interest in Pakistan’s economy. Some influential independent economists also wrote a series of articles on the subject. The main thrust of the articles was that if the pace of debt accumulation was not checked, Pakistan’s public debt in general, and external debt in particular, would reach an unsustainable level by 2019-20. The size of the external debt in particular would become too large for Pakistan to service them in an orderly manner, and subsequently, would create serious balance of payment crisis for Pakistan.
While these articles appear to have made some impact in different quarters, these have certainly unnerved the country’s finance minister who reacted in a hostile manner by writing a lengthy article on Pakistan’s debt (see Business Recorder, February 1, 2017). He charged independent economists, including myself, without naming them, for being selective in presenting information, misinterpreting the facts, predicting doomsday scenario for Pakistan’s debt, venting bias through writings, and most importantly committing disservice to the nation.
He presented his own narrow definition of debt in the article, which is different from the standard ones used by other independent economists, international financial institutions (the IMF, World Bank etc.), rating agencies, and myself.
He presented various indicators of the country’s debt burden based on his own definition of debt. Contrary to what the independent economists were arguing, the finance minister showed that the country’s debt burden has in fact been reduced.
While we, the independent, appreciate the efforts of the Finance Minister for taking pains to explain his position on debt at greater length, we however regret and dismiss the various charges that he has leveled against us. In particular, the charge of committing disservice to the nation is in bad taste, and should have been avoided. A debate on a particular issue in the press is considered healthy in a democratic society. People may not agree with each other but they do not accuse each other of committing disservice to the nation. Not tolerating dissenting views is akin to a dictatorial mindset.
The independent economists urge the Finance Minister to remain calm and respond to his critics in a professional manner.
The purpose of this article is many folds. Firstly, I would like to dwell upon the definition of debt and its evolution through the historical facts. Secondly, how the Finance Minister changed the definition of debt in June 2016, and subsequently, I would highlight the differences in the conventional and changed definition of debt. The readers would see the extent of understatement of external debt and liabilities as defined by the Finance Minister. Thirdly, I would like to update the external debt scenario for the period up to 2019-20. The final section would feature my conclusion on the matter and some policy suggestions.
Definition of Debt
On the definition of debt, I would like to bring to the notice of the general readers, as well as of the Finance Minister, the matter of some historical facts. Pakistan faced serious debt crisis in the decade of the 1990s. On 29 January 2000, the then government constituted a high-powered Debt Reduction and Management Committee (henceforth Debt Committee) to assess Pakistan’s debt situation, analyze its evolution, ascertain its impact on the economy, provide recommendations to bring the debt under control, and most importantly, suggest the definitions of debt – both public and external – which is consistent with global practices.
Dr. Pervez Hasan, a Pakistani and a former Chief Economist of the Asia-Pacific region at the World Bank, chaired the high level Committee. The other members of the Committee included Mr. Mueen Afzal (Secretary General Finance), Dr. Ishrat Hussain (Governor SBP), Mr. Nawid Ahsan (Secretary, Economic Affairs Division), Mirza Hamid Hasan (Secretary, Statistics Division), Mr. Fateh Chaudhri, Mr. Bashir Ahmad (Chairman, Islamic Investment Bank), Mr. Khurshid Marker, Dr. Ayesha Ghous Pasha (the current Finance Minister of Punjab), Dr. Aliya H. Khan and Dr. Ashfaque H. Khan (myself), as Member/Secretary.
After extensive deliberation the Committee completed its work and submitted the Report under the title “A Debt Burden Reduction and Management Strategy” to the then Finance Minister. Besides analyzing the debt situation of the country, the Committee also prepared two tables (Table 1 and 2 of the Report) that dealt with External debt and Public debt, respectively, to streamline definitions of debt. External debt included:
I. Public and Publicly Guaranteed Debt
– Medium and Long Term Debt
– Other Medium and Long Term Debt
– Euro Bond
– Short – Term Including IDB
– IMF Debt
– Central Bank Deposits
II. Private Non-Guaranteed Debt
III. Debt Obligation to Residents in Foreign Exchange
– Bearer Certificates
– US & Bond
IV. Other Foreign Obligations
– Foreign Currency Accounts
– FE-25 Deposits
Public debt included debt payable in rupees and debt payable in foreign exchange converted in rupee by multiplying with the exchange rate. After the approval of the Debt Committee Report by the Cabinet on 15 February 2001, the Ministry reconciled the debt numbers with Economic Affairs Division, SBP and the Ministry of Finance to arrive at one number for debt – both public and external – for Pakistan. Since Pakistan was under the IMF Program, the debt numbers of Pakistan were also reconciled with the IMF and the World Bank. Pakistan produced debt numbers thereafter, which were also consistent with the IMF and the World Bank – of course with minor adjustment/refinement over the years. Pakistan continued to publish debt numbers in Pakistan Economic Survey – an annual State of the Economy report of the country. These numbers were consistent with the IMF and were reported in all the Review documents of the IMF since then.
Finance Minister’s Definition of Debt
It has been a common practice of this government to change the definition of the variables if their performances are not improving. For example, the government changed the definition of taxes, revenue, expenditure, budget deficit, unemployment, etc., to show higher tax-to-GDP ratio, lower budget deficit and lower unemployment rate.
Following the same tradition the finance minister changed the definition of both public and external debt in June 2016.
The speed at which the Finance Minister borrowed both externally and domestically, raised serious alarm in the comity of independent economists, print and electronic media, and general public at large.
Realizing the fact that the pace of borrowing could not be slowed and that the public debt to GDP ratio was on the rise and remained perpetually in violation of the Fiscal Responsibility and Debt Limitation Act 2005, the Finance Minister thought it right to change the definition of debt.
How the definition of debt was changed?
Before changing the definition, did the finance minister arrange a public debate at any public forum? Was this issue discussed in print or electronic media? Was this change in definition discussed in Parliament or even in the standing committees of the National Assembly or Senate? The answer to all these questions are in the negative. Changing of the definition of debt through amendment in the Fiscal Responsibility and Debt Limitation (FRDL) Act 2005 was never discussed at any forum – be it public, print or electronic, or parliament.
The FRDL Act 2005 was amended, and so was the definition of debt – both public and external. This was done silently through the Finance Bill and it speaks volume about the true intension of the Finance Minister. On the contrary, the FRDL Act 2005 was discussed and debated widely for several years, both within and outside the Parliament.
Many independent economists, myself included, have serious reservations over the definition of external debt of Finance Minister. His definition is not at all aligned with the IFIs definition (IMF and World Bank), as well as the one we have been reporting in our writings and presentations. Our definition of external debt is consistent with the IFIs, and on the basis of this definition that we have been forecasting the growing debt liabilities of Pakistan. It is on this forecast that the Finance Minister has charged us for presenting a doomsday scenario, and that we have committed or are committing a disservice to the nation.
Is forecasting external debt on the basis of standard definition (as suggested by the Debt Committee and approved by the Cabinet and also used by the IFIs) – howsoever may be disliked by the Finance Minister – a disservice to the nation; or is understating the debt, and keeping the nation in the dark, a disservice to the nation? I leave this to the people of Pakistan to decide.
As professional economists, our universities have taught us that transparency is the linchpin of good governance. Our universities have also taught us that hiding facts and misguiding the people are truly a disservice to the nation.
The Finance Minister used his definition of external debt and calculated that the burden of debt has in fact declined over the last three years when compared with the past five years of the previous regime.
Let me in turn show the difference between Finance Minister’s definition of external debt and the one used by the IFIs and ourselves. The table below clearly highlights the differences and the extent of understatement.
A cursory look at the table is sufficient to see that the Finance Minister has defined the external debt too narrowly. On the other hand, the standard definition, which is consistent with the Debt Committee Report approved by the Cabinet, as well as consistent with the ones used and reported by the IMF and the World Bank, are extensive and truly represent the country’s debt burden. As opposed to Finance Minister’s definition of debt ($57,757 million), the external debt on the basis of standard definition amounted to $73,063 million as of end-June 2016. During the first quarter (July – September) of 2016-17, it has further increased to $74,638 million. Accordingly, the Finance Minister has added $12.164 billion external debt and liabilities in three years as against $14.738 billion in five years by the previous government. In this respect, the Finance Minister’s speed of borrowing was certainly faster than those of previous regime.
External Debt and Liabilities Forecast
It is this pace of borrowing which has created alarm in the country. The readers would recall that in my earlier article under the title of “Rising Debt: A Threat to National Security”, I presented the forecast for 2015-16 to 2019-20. My forecast for the year 2015-16 was that Pakistan’s external debt and liabilities would reach $69.8 billion and that exports would reach $23.2 billion.
To my surprise, and to the surprise of all those who have interest in Pakistan’s economy within and outside the country, including the IFIs, the debt reached to over $73 billion in 2015-16 – $3.26 billion more than the forecast. The Finance Minister surprised everybody by adding almost $8 billion in external debt in one year, that is, in 2015-16 alone. Similarly, exports, instead of the $23.2 billion forecast, actually stood at $22 billion – $1.2 billion less than the forecast. Extraordinary increase in external debt on the one hand and extraordinary decline in exports on the other have further aggravated the debt burden of the country. The reason why my forecast was off the mark was that Pakistan, of late, has increased its borrowing from non-traditional sources, such as private foreign commercial banks. It is in this background that I have revised my forecast for the period 2016-17 to 2019-20. Pakistan’s external debt and liabilities are projected to rise to $80.3 billion in 2016-17, probable to rise further to $88.5 billion in 2017-18, and expected to reach $110.0 billion by 2019-20 (See Table 1).
Accordingly, external debt servicing is projected to be $7.0 billion in 2016-17 and expected to reach $10.0 billion by 2019-20. Exports of goods and services is projected to be $25.6 billion in 2016-17 and projected to rise slowly to $30.1 billion by 2019-20. Accordingly, Pakistan’s external debt and its liabilities as percentage of exports of goods and services are projected to rise from 266.4 percent in 2015-16 to 313.7 percent in 2016-17, and further to 365.4 percent by 2019-20. Similarly, external debt, servicing as percentage of exports of goods and services is projected to rise from 24.1 percent in 2015-16 to 27.3 percent in 2016-17, and further to 33.2 percent by 2019-20. In other words, external debt servicing will consume one-third of exports of goods and services by 2019-20 (See Table 1).
What will be the financing requirement for Pakistan during 2016-17 and onward?
Pakistan will require financing (dollar) for external debt servicing and for financing current account deficit. The emerging scenario is documented in Table 2. Financing requirement for the current fiscal year (2016-17) is estimated at $14 billion, that is, $7.0 billion for debt servicing and $7.0 billion to finance the current account deficit. Financing requirement is projected to rise to $22.5 billion by 2019-20, that is, $10 billion will be required to service external debt obligations, and $12.5 billion to finance current account deficit. We expect current account deficit to deteriorate owing to the rise in import bill on two counts – firstly, oil prices is expected to rise from the current level in the next three years and secondly, CPEC – related imports are expected to gain momentum. Exports are not expected to match the increase in pace consistent with the rise in import.
What will be the likely financial inflows? These are well – documented in Table 3.
Financial flows from traditional sources, foreign investment and financing from China for the CPEC – related projects for the next four years are presented in Table 3. Financial inflows of $8.5 billion are likely to be received in 2016-17, which is expected to rise to $11.0 billion by 2019-20. The most important element in external balance of payment is the likely financing gap. This is the gap between the likely foreign exchange requirements and the likely inflows of external financing from various sources.
Table 4 documents the financing gap for the next four years. A cursory look at the table 4 suggest that a financing gap of $5.5 billion is expected in 2016-17 but this gap is projected to rise $11.5 billion by 2019-20, which will certainly not be possible to fill without the massive injection from the IFIs, including the IMF.
The pace with which Pakistan is accumulating debt over the last eight and a half years in general, and three and a half year in particular, has raised serious concerns among independent economists, as these are segments of society which matter for the security of the country and general public. As mentioned earlier, a detailed article I wrote on this issue last year generated considerable interest within and outside the country.
The country’s Finance Minister reacted to these writings by responding to his critics through a lengthy article on this subject. After carefully evaluating his article we realized that the debate on this issue is a futile exercise because the minister has changed the definition of external debt, which is not consistent with standard definition used by the IFIs and us. He changed the definition unilaterally – in other words, the change of definition was not discussed in any public platform or even in the parliament. The definition was quietly changed through Finance Bill 2016.
In this article, I presented the definition, which was finalized by the high level Debt Committee in early 2001. The various departments of the government reconciled the definition and arrived at a uniform number for external debt. The same definition and the numbers were reconciled with the IFIs. Till date, the IFIs are reporting the debt numbers, which are being used by all and sundry, except the Finance Minister, since 2013 onwards. I also highlighted the differences of standard definition versus the Finance Minister’s definition of external debt.
Based on the standard definition of external debt and liabilities, I updated my last year’s forecast for the period 2016-17 to 2019-20. If the current pace of accumulation of debt continues, Pakistan’s external debt and liabilities are projected to rise to $80.3 billion in 2016-17 from $73 billion of last year. By 2019-20, these are projected to rise from $110 billion. External debt and liabilities as percent of exports of goods and services are projected to rise 266.4 percent in 2015-16 to 313.7 percent in 2016-17, and further to 365.4 percent by 2019-20. This is indeed unsustainable and may put Pakistan in an extremely difficult situation by 2018-19.
Rising debt is bound to give rise to external debt servicing, for which the country needs foreign exchange to pay. The country also needs foreign exchange to finance rising current account deficit. Hence, Pakistan’s external financing requirement is projected to rise to $14 billion in 2016-17 and further to $22.5 billion by 2019-20. The likely flows from traditional sources, Chinese sources and from foreign investment together is projected to rise from $8.5 billion in 2016-17, to $11.0 billion by 2019-20. The financing gap is therefore projected to rise to $5.5 billion in 2016-17, and gradually to $11.5 billion by 2019-20.
How this gap is going to be financed is a million dollar question. Who will bridge such a large gap? Can the IFIs including the IMF come forward to bridge the gap? Will there be a benign IMF again in a changing global political scenario? I leave this to my fellow independent economists and to those who have interest in Pakistan’s economy to shed light on this issue.
My simple advice to the Finance Minister is that he needs to be transparent and must realize that changing definition of variables is no solution. He should face the challenge boldly through effective policies.