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To Borrow or not to Borrow

To Borrow or not to Borrow
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The highly volatile exchange rate, depreciating currency value, and lack of policy commitment exacerbated the augmenting debts

Ashfaque Sangi

The COVID-19 pandemic severely struck the whole world in 2020 and adversely affected the economic systems, causing unprecedented ballooning of public debt and deficits and turning the GDP negative. Some countries took swift measures to save their economies. Pakistan also adopted some measures to control the damage; however, one crisis overlapped with another, putting the country’s economy into a continuous state of turmoil. The weak economy was strongly hit by the pandemic, and, when there were some mild signs of recovery, political instability worsened the situation, and the country is now on the verge of default. This is a story of a resource-blessed country with a worrisome economic history—Pakistan.

There is no denying that emerging markets like Pakistan face myriad financial problems; one such key issue is the increasing public debt, especially after the COVID-19 pandemic. Public debt is one of the vital instruments to bridge the financial gaps of governments. Its efficient use can boost economic growth and development. For the last six decades, Pakistan has frequently borrowed from external and domestic sources, causing the public debt to balloon to 84% of the GDP from 58.9%1 in 2011 (State Bank of Pakistan 2020).

Governments worldwide seek to guarantee the sustainability of public debt and economic growth to stabilize the macroeconomic indicators. However, they sacrifice investment when they are saddled with ballooning debt burdens, thus diverting considerable resources to debt servicing at the expense of employment opportunities and economic growth. Rising and unserviceable debts push countries toward debt distress, thus causing them to seek assistance and bailout packages. Such situations lead to unsustainability – being unable to meet their financial obligation (e.g. interest plus the principal amount), putting them at risk of default, as recently witnessed in Sri Lanka.

Over the decades, Pakistan has been facing such traditional concerns due to the mushrooming of fiscal deficits and the maturity of the country’s external debt. Pakistan’s fiscal deficit peaked at 8.1% of its GDP in 2020 from 6.5% in 2011 (Pakistan Ministry of Finance 2021). Such high fiscal and current account deficits lead to dependence on foreign borrowing.

As a result, reducing public debt is a major challenge for macroeconomic stability and sustainable economic growth. To put this into context, the total public debt to revenue amounted to 667.4% of the GDP in 2020 from 479.2% in 2011 (Pakistan Ministry of Finance 2020). Unfortunately, both the public debt and the budget deficit are increasing compared with the GDP growth in Pakistan. This partly shows that the country has been facing economic mismanagement over the last few decades. The worsening condition of debt accumulation indicates that the country will soon be on the brink of a debt crisis.

Therefore, it is pertinent to examine the sustainability of public debt. Besides borrowing, the empirical literature has also proposed three alternative sources of deficit financing. Firstly, monetizing debt leads to inflation. Secondly, the use of foreign reserves creates a balance of payment crisis and crowds out private investors. Thirdly, increasing taxes lead to distortions, as suggested by the Laffer curve. This is why governments turn to borrowing from internal and external sources. 1 The standard debt sustainability limit is a 60% debt-to-GDP ratio.

Various studies have shed light on the burgeoning debt and its repayment impacts. If an economy faces a debt overhang, then the fiscal factors deteriorate over time, adversely affecting investment and reducing economic growth. The low GDP growth and budget deficits push economic into quandary, leaving no viable fiscal options, as a large chunk of government revenues is used for debt servicing. Loser (2004) showed that Highly Indebted Poor Countries (HIPCs) experience a lack of new funds due to debt servicing.

Besides this, poorly structured debt in terms of currency or interest rate composition, maturity, and unfunded and huge contingent liabilities have been the main reasons for the economic crisis in various countries. In the case of Pakistan, the country scores poorly on most ratings of debt metrics compared with its regional peers—whether foreign exchange reserves for import cover, liquidity ratios, stock measures, or the debt servicing burden. The current low FX reserves and high debt levels indicate that Pakistan is facing a double-edged sword and has very little space to deal with exogenous shocks. The budget document (2020–21) highlighted that Pakistan had spent 60% of its revenue on debt servicing. Such a large portion of revenue used for debt servicing left little for other development activities and social welfare. The highly volatile exchange rate, depreciating currency value, and lack of policy commitment exacerbated the augmenting debts.


Ashfaque Sangi is based in Larkana Sindh



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