Pakistan’s inability to live within its means has resulted in persistent macroeconomic imbalances and necessitated numerous financial support programs with the International Monetary Fund (IMF). Large fiscal deficits year after year have translated into a rapidly rising public debt burden and a ballooning public interest bill.
By 2022/23, interest payments on public debt were eating away a whopping 60 percent of government revenue. Only a few countries have managed to hold such persistently high diversion of fiscal revenues to debt service. On the external side, recurring current account deficits coupled with a strong rupee policy have led to sporadic devaluations whenever reserves drained to unusually low levels. Additionally, difficulties in refinancing external debt coming due have increased as the ratio of annual external amortization (principal repayments coming due) to reserves has grown over time (Table 1).
Table 1: Gross external financing requirements
The latest economic crisis gripping Pakistan germinated during the global pandemic, exacerbated by the commodity price shocks that followed the outbreak of the Russia-Ukraine war. Unaffordable policy support in the form of expanded government spending, especially through increased energy price subsidies and heavily subsidized bank loans via special credit schemes introduced by the central bank, further widened the already substantial fiscal and external deficits.
By the middle of 2021/22, it became clear that these imbalances were unsustainable. The fiscal year ended with a budget deficit of almost 8 percent of GDP, an external current account deficit nearing 5 percent of GDP, alongside rapidly depleting reserves, and imports expanding at a 60 percent pace for part of the year. The sharp exchange rate depreciation necessitated by the crisis raised the rupee value of external debt and increased its share in total public debt. At present, public and publicly guaranteed debt amounts to 75 percent of GDP, of which about 40 percent is foreign currency debt owed to external creditors.
This dire situation has led many to wrongly advocate for debt default and restructuring as the right remedy for Pakistan, despite the significant pain and severe economic disruption it would cause to the country. Indeed, it seemed inevitable that Pakistan would have to follow the path of a growing number of heavily indebted emerging market economies by defaulting and seeking to restructure its debt. However, Pakistan’s debt structure—with almost all interest payments directed towards domestic creditors and the bulk of its remaining external debt owed to official creditors—renders the potential gains from default/restructuring rather slim, while the associated costs are massive, in particular for the domestic banking system. On the other hand, the recently approved IMF program envisages the right reforms, but insufficient concessional financing from official creditors threatens to derail it by forcing an unrealistic spending path. Critics arguing that the current strategy could fail have a point.
This note, by Aasim M. Husain, proposes an alternative path to both debt restructuring and excessive belt-tightening. Instead, he proposes a strategy to reduce the burden of the interest bill through fiscal adjustment, growth-enhancing investments, and structural reforms.
Raising revenues should be possible, as Pakistan is one of the countries that collects the lowest level of taxes in the world. With enough horizon, this would allow the country to maintain expenditure at a reasonable level – though low, relative to other countries. Such limited adjustment could enhance growth, but it would only be feasible if it is backed by sizable, coordinated liquidity support from official creditors at concessional interest rates. To encourage creditors to work together to deliver the support needed, Husain pleads for increased transparency surrounding the liquidity relief that needs to be provided and puts forward a mechanism for doing so in the paper. The success of such an approach in Pakistan could well serve as a model for other countries encountering similar debt problems.