INTRODUCTION

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 economic revival.

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 poverty.

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 four countries.
(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 management projects.

(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.