Times have changed for Pakistan with the onset of
the war against terrorism. From being politically isolated and persistently
on the verge of debt default, Pakistan has suddenly become a front line
state with the western world offering to help resolve its financial crisis
in order to enable a revival of the real economy. The financial crisis
consists of such severe fiscal constraints on the government that on its
own, it is unable to take any major initiative for stimulating the stagnating
economy and attacking poverty. In this context the essential fact is that
in 1999-2000 interest payments constituted over 60% of government's tax
revenue. Therefore resolving the debt servicing problem is the key to
overcoming the financial as well as the underlying economic crisis.
In this article we will first examine the nature of
Pakistan's debt problem and its relationship with economic growth and
poverty. We will then examine the various elements of external debt to
indicate how a debt relief package could be combined with a strategy for
DEBT VERSUS DEVELOPMENT
External debt, increased from US $ 10 billion in June
1980 to a peak of US $ 43 billion in May 1998. Debt servicing as a percentage
of foreign exchange earnings rose even more sharply from 18.3% in 1980
to 40% in 1997-98. The rapid increase in the debt servicing burden reflected
the increasing weight of interest payments, especially after the substantial
high cost borrowing following the 1996 foreign exchange crisis. In 1998
a second foreign exchange crisis occurred after economic sanctions associated
with Pakistan's underground nuclear tests. At this stage the government
found it impossible to meet its debt servicing obligations in view of
the fact that short-term debt could no longer be rolled over, and the
foreign exchange reserve was extremely low. The government responded by
freezing the foreign currency deposits held in Pakistan by individuals.
Subsequently the government sought help from the Paris Club to reschedule
debt payment. Nevertheless Pakistan's external debt still stood at US
$ 35 billion in the year 2000.
The rapid build up of debt, while it may be rooted
in poor governance in Pakistan has had significant adverse implications
for GDP growth and poverty. Governments in the past had spent an increasing
proportion of loans on non-development spending (current expenditure),
to prop up their power base. The excess of current expenditure over government
revenue increased dramatically in the last two decades. During 1980-85
the government revenue exceeded current expenditure by Rs. 2.3 billion.
By 1999-2000 current expenditure was in excess of government revenue by
as much as Rs.96 billion.
Given the structure of governmental power, successive
regimes when faced with fiscal pressures, chose to cut down development
expenditure rather than expenditure on government itself. In fact current
expenditure (primarily due to debt servicing) increased so sharply during
1980-1999 that inspite of a huge reduction in development expenditure,
fiscal deficits did not decline significantly.
Annual development expenditure has historically played
a significant role in building infrastructure and generating secondary
multiplier effects on GDP and employment. In the period 1980 to 1999 development
expenditure fell from 40% of total government expenditure in 1980-81 to
13.5% in 1999-2000. The adverse effects of this trend on GDP growth were
exacerbated by the growing inefficiency of development expenditure induced
by politically motivated projects and widespread corruption associated
with the decay of the government's institutional capacity. Thus the sharp
reduction in development expenditure combined with declining effectiveness
in its use may have been significant factors underlying the phenomenon
of deteriorating infrastructure, decelerating growth of GDP and accelerating
DEBT RELIEF FOR DEVELOPMENT
Let us examine what a debt relief package could look
like and how it could be focused on accelerating GDP growth and reducing
poverty. Out of the total medium and long term external debt of US $ 26.89
billion as much as 51% is multilateral debt owed to institutions such
as ADB, World Bank, IDA and IFAD. Of the remaining US $ 13.31 billion
of medium and long term external debt 78% is owed to only four countries.
These are, Japan (US $ 5.3 billion), USA (US $ 2.9 billion), Germany (US
$ 1.1 billion) and France (US $ 1 billion). A debt relief package could
have the following three elements:
(a) Bilateral debt write off by the aforementioned
(b) Restructuring the multilateral debt profile by extending the re-payment
period and reducing the interest rate.
(c) Rescheduling short term debt for the next four years.
The objective of this debt relief package should be
to reduce the debt servicing burden from an intolerable US $ 4.9 billion
annually to US $ 1.9 billion. This would bring down the annual debt servicing
burden from a suffocating 40% of foreign exchange earnings to-day to 15%
of foreign exchange earnings. Then the economy could breathe again and
its revival taken in hand. However given the past experience of capital
inflows (discussed in my article on October 5, 2001 in the Friday Times),
it may be prudent for both foreign donors and the government to link debt
relief with a specific economic programme of reform and revival. This
programme could be called Debt for Human Development Swap and could focus
on five dimensions:
(1) Facilitate growth in those sectors of the economy
which for given levels of investment can simultaneously generate higher
GDP growth, higher employment and higher exports. These sectors include
export oriented labour intensive activities by lower income groups of
society such as milk production, fisheries, vegetables and fruit farming.
It would also include small scale high skill labour intensive industries
such as software, electronics, light engineering, specialized garments,
sports and surgical goods.
(2) Building of water sector infrastructure to improve
the availability of water and the efficiency of irrigation. This would
include small dams, water course lining, land leveling and on-farm water
(3) Building vitally needed infrastructure in transport and communications
to create a facilitating environment for private sector investment.
(4) Social sector development to improve health and education services
and participatory poverty alleviation projects to enable the poorest sections
of society to increase their incomes.
(5) Projects for improving the physical environment so as to reduce soil
depletion, air and water pollution and salinity and water logging.
The fiscal space that a possible relief package could create needs to
be judiciously used through new contracts between donors and the government.
The finance released by the debt relief package should be carefully directed
through efficient implementation and monitoring mechanisms so that GDP
growth can be accelerated, and restructured in such a way that it can
rapidly reduce poverty.