Pakistan’s received $3.110 billion out of a total of $7.2 billion in external debt in the first eight months of this fiscal year. An increase in this proportion could hurt the economic growth of Pakistan.
The Global Debt:
The Global debt reached a record $281 trillion by the end of 2020, according to the Institute of International Finance (IIF).
Governments with big budget deficits are set to increase the debt by another $10 trillion this year, pushing this debt to $92 trillion by the end-2021, the IIF estimates.
Why Countries Take External Debt? Why Debt Becomes An Issue For Developing Nations?
Countries borrow from foreign companies mainly to finance their excess expenditures, build additional infrastructure, finance recovery from natural disasters, and even repay their previous external debt.
Governments usually do not prefer external debt, since they impose restrictions on the borrowing country and give the lender country some leverage over them. Though, certain circumstances compel countries to borrow money from outside, some of which are as follows:
- When the domestic financial institutions and banks lack sufficient money to lend.
- The local funds are only available to be utilized in other essential areas, such as healthcare, natural disasters, and education.
- Global financial institutions and foreign governments offer debt on lower interest rates and easier repayment schemes than the domestic debt market.
Inflows from external debt provide some ease on the fiscal front and help the nations to grow. However, higher fiscal imbalances, inefficient use of resources, and rescheduling of external debt lead to a higher level of the external debt stock. Additionally, lower exports, inflexible imports, and lesser capital inflows, servicing of external debt becomes an issue for less developing economies.
To service their ongoing external debt repayments, many developing economies raise more external debt, which not only expands their fiscal deficits but also results in debt overhang. Many developing countries cut their developmental expenditure for repayment of the debt, which harms the economic growth.
Although developing economies struggle for a higher economic growth trajectory, but due to the current deficit, and low capital formation economic growth increases gently. Hence, the dependence of these economies increases over foreign borrowings from the last decades. Given the poor economic indicators and limited fiscal space for servicing the external debt, most of the International donor agencies provide funds at specific conditions. These conditions commonly include fiscal prudence, economic and political stability, a sound banking system, lower cost of doing business, and an environment conducive for investment to ensure further assistance.
Developing economies typically have limited sources to raise revenues. If they fail to channel external funds to enhance productivity and create new employment opportunities; they eventually stuck up with lower tax revenues in contrast with higher debt servicing, thereby leading to a higher current deficit. Moreover, the inability to service debt on time not only makes it harder for the developing countries to get aid at concessional rates with less conditionality from the donor agencies but also increases the sovereign risk. That in turn reduces the flow of foreign direct investment in the country and increases its reliance on domestic resources which disrupts the balance between fiscal and monetary policies and leads to crowding out that further slows down the economic growth.
Current Situation of Pakistan:
Pakistan has experienced a fiscal deficit, Due to the lack of a strong private sector and well-established banking system, Pakistan borrows extensively from external sources such as IMF. With cheaper bilateral and multilateral flows becoming insufficient, the government’s reliance on expensive foreign commercial debt is soaring.
Pakistan takes foreign commercial loans of USD 3.11 billion and USD 1 billion from Chinese deposits during the current fiscal year. With the combination of foreign commercial loans and safe deposits, Pakistan received over USD 4.1 billion that was over 50 percent out of the total received foreign dollar inflows from creditors.
While Pakistan has to repay $4.4 billion on account of foreign commercial loans during the current fiscal year, indicating a pressure building up on forex reserves amid uncertainty over IMF’s stalled program.
Why did Pakistan turn Into A Heavily Indebted Nation?
There are multiple reasons why Pakistan borrows heavily from external sources. The exponential growth in foreign debt levels underscores that the country has been incapable to attract adequate non-debt-creating, long-term inflows like FDI or increase its exports to meet its external account requirements. The extremely low level of formal domestic savings implies that the government would have to depend on foreign savings to fulfill its budgetary operations. Considering the foreign exchange constraints, financing of development projects and failure in development of tax system is a major factor behind heavy foreign borrowings.
The Pakistan’s external debt continues to accumulate and it has to borrow more dollars to repay its old loans suggests that the country has been caught in a debt trap. Since July 1, 2018, the government has accumulated $23.6bn in foreign debt. The external debt rose by $10.7bn in the last financial year and $8.4bn in 2018-19 with debt servicing becoming the largest budget expense.
According to official data, the government paid back $2.45bn in the first four months of the current fiscal against repayment estimates of $10.4bn for the entire year — this, despite debt payment relief allowed by bilateral lenders to countries like Pakistan because of Covid-19. That shows the government will continue to borrow more money to repay its old loans while accumulating more debt. This is not effective for any economy, least of all a fragile one. The government should attract FDI, boost exports, increase tax revenues and incentivize domestic savings to get out of this trap.
How Foreign Debt Can Become A Problem For Pakistan?
In Pakistan, Higher external debt stock eats up the fiscal revenues and leaves lesser space to run the country. Therefore, either we try to tap more resources from abroad to maintain economic stability or slash their capital expenditure, which in turn hampers economic growth.
Pakistan with higher external debt has to meet the interest payments on the debt. This can only be met
we earn foreign currency from exports, Gold reserves or foreign currency reserves, or further borrowing.
The external debt may affect the economic growth of Pakistan in the following ways:-
- Through debt overhang effect:- Debt overhang refers to a debt burden so large that an entity cannot take on additional debt to finance future projects. In this situation, when an accumulated debt, discourage and o verhang investment, mainly private investment; as private investors expect an increase in tax by the government to pay the accumulated debt.
- Through debt crowding out effect, this is a situation when Pakistan used to pay the accumulated debt from exports income. This in turn may affect investment in the country.
- Growing external debt in Pakistan can discourage foreign and private investment because of concerns that the debt is becoming unsustainable.
- Due to unexpected devaluation in the Pakistan exchange rate, the real value of debt interest payments increases denominated in dollars.
- The investment is misplaced and fails to achieve a decent rate of return to help pay the debt interest payments. For example, developing countries may struggle to make use of funds for industrialization if they lack the necessary skills and infrastructure.
How Pakistan Could Reduce the Burden of External Debt?
Pakistan needs to mobilize its external resources to enhance productivity so that it can help to create new opportunities. These opportunities include revenue earning, employment, investment and attract more investors to their countries. With or without the IMF, we urgently need a credible fiscal consolidation plan. In turn, it will boost market confidence and lead us into the growth phase. With or without the IMF, we urgently need to undertake structural reforms. The consequence of structural reforms is growth-and growth will take us out of the debt trap we are in.
Pakistan cannot come out of this economic hole unless it starts receiving more revenue in the form of taxes. Pakistan citizens are unwilling to pay taxes because of the problems like corruption. Pakistan needs to do two things. Firstly, the level of economic activity needs to be increased so that more taxes are owed to the government. Secondly, a culture of tax compliance needs to be taught. This culture can only be inculcated if there is a strict penalty for non-obedience.