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A Note on FM Isaq Dar Article “Public Debt Management”

March 20, 2016

This is apropos finance minister Ishaq Dar’s article ‘Public debt management’ carried by the newspaper on Saturday. Good public debt management contains financial risk. It develops domestic debt market and helps in reducing the borrowing cost. Such an approach facilitates maintaining financial stability and helps to develop in strengthening domestic financial system.

But the key to effective management of public debt for low income country like ours differs from what is practised in developed countries, as “Cookie Cutter” approach will never be helpful. It is required that debt management strategy should support overall Macroeconomic Policy framework to maintain stable conditions that should be conducive to growth.

What is Pakistan’s approach to managing its public debt? There is almost zero policy co-ordination between State Bank of Pakistan and Ministry of Finance. Former Governor SBP Shahid Hafiz Kardar having no real banking sector experience, as his past affiliation with Royal Bank of Scotland is nothing quite credible.

Soon after taking the charge he decided to quietly wind up SBP Debt’s Cell for reasons best known to him. The decision was gruesome for Pakistan’s sovereign debt market, as the objective of the guidelines of debt cell is to always assist policymakers to consider reforms to strengthen the quality of the Public Debt Management and reduce country’s vulnerability to financial shocks and all shortcomings. Sovereign debt is vital for the development of a credit market. Active credit market assists issuance of Sovereign Debt.

Unfortunately, however, Kardar’s replacement was another bad choice for the market as Yasin Anwar being a stranger had no idea about Pakistani market and norms.

The incumbent SBP Governor, Ashraf Wathra, is a professional banker and is certainly a better choice; he has effectively managed exchange rate and inflation/policy rate. He may not be the best, but his decision on implementing financial and price stability is appropriate in meeting the required standards. In recent times market has witnessed SBP’s influence over exchange rate policy and setting of objectives for both monetary and exchange rate policies.

His contribution towards Real Economic Growth is below the desired level. This could be due to excessive pressure from Ministry of Finance to encourage banks to invest in government securities, which in proportion to bank deposit is the highest in the world.

Let’s do a case study and dig deeper to find the truth. There are quite a few monetary angles which need to be discussed more in detail.

Here are some glimpses of past and present data that should help:

— The size of economy in 1999 was USD 75 billion, in 2008 it was USD 170 billion and in 2015 USD 271 billion.

— In 1999, GDP Growth was 4.2 percent, in 2008 6.8 percent and in 2015 4.2 percent

— In 1999, inflation was 5.7 percent, in 2008 7.8 percent and in 2015 below 3 percent

— In 1999, fiscal deficit/GDP was 5.1 percent, in 2008 4.2 percent and in 2015 5.3 percent (FY15)

— In 1999, Rs/DLR parity was 51.90, in (FY 2008) 67.20 and 104.65 (current).

— GDP per capita income in 1999 was USD 450, in 2008 USD 1085 and in 2015 USD 1513.

— In 1999, tax revenue was Rs 391 billion, in 2008 Rs 990 billion and in 2015 Rs 2.588 trillion.

— Exports in 1999 were to the tune of USD 7.8 billion, in 2008 USD 19.22 billion and (FY15) USD 24.087 billion.

— Imports in 1999 were worth USD 9.9 billion, in 2008 USD 39.996 billion and in FY15 USD 41.309 billion.

— Foreign Direct Investment in 1999 was 472 million, in 2008 USD 5.19 Billion and in 2015 USD 2.767 billion.

— Total debt (external and domestic) in 1999 was Rs 2.907 billion, in 2008 Rs 6.475 billion and in 2015 Rs 18.467 billion.

— Interest payments on debt in 1999 were Rs 340 billion, in 2008 Rs 642 billion and in Rs 2015 Rs 1.284 trillion.

— The size of PSDP in 1999 was Rs 80 billion, in 2008 it was Rs 550 billion and in 2015 Rs 700 Billion.

— Foreign exchange reserves in 1999 were USD 991 million, in 2008 was USD 16.5 billion and in 2015 USD 18.699 billion

— Expenditure on education/GDP in 1999 was 1.82 percent, in 2008 2.43 percent and in 2015 was 1.78 percent.

— Total deposits of scheduled banks in 1999 were Rs 1.113 trillion, in 2008 Rs 3.8 trillion and in 2015 Rs 9.305 trillion. `

— Total advances of scheduled banks in 1999 were Rs 1.533 trillion, in 2008 Rs 3.271 trillion and in 2015 Rs 4.781 trillion.

— Credit to private sector in 1999 was Rs 84.4 billion, in 2008 Rs 370 billion and in 2015 Rs 212 billion.

— Banks Weighted Average Lending Rate in 1999 was 14.6 percent, in 2008 10.32 percent and in 2015 8.7 percent.

— Excessive borrowing to meet External Financing without a payment plan confirms a lack of strategy.

— Where have the USD 13 billion oil savings disappeared – a point not discussed by finance minister Ishaq Dar in his article?

— A 3-6 percent exchange rate moving either way is a common phenomenon in the international market. This type of move in major currencies occurs in a single day.

However, the cause of fall was caused by demand to honour trade commitments (Oil & MOD payments). Speculators took advantage of the situation and jumped in a bandwagon, which is not interbank market responsibility. Exporters – like ever – became greedy and were holding foreign exchange in a hope to make a quick buck.

Since SBP was defending Fx Reserves through verbal intervention, it did not prove to be a very effective tool, as US dollar liquidity dried up. Instead, a bad precedent was set when FE 25 US Dollar Deposit, which is FC Depositors money, was used to settle payments. And lastly the credit for effectively managing exchange rate goes to SBP and MoF. Islamabad is not supposed to interfere in SBP’s affairs.

— The cost of shift of Government Paper from shorter maturities to longer maturities was too high a price that taxpayers have to pay. PML (N) is in office for the last 32 months. In July 2013, banks’ holding of Government Securities (GOP) was Rs 615.5 billion that has surged by Rs 5.423 trillion to Rs 6.039 trillion. To support bank investments in GOP, SBP through its Open Market Operations (OMOs) has injected Rs 1.471 Trillion. The average return on investment ranges well above (2) two percent. Imagine the cost nation has to pay for such types of transactions.

This is why banking sector profit after Tax for 2105 has surged to Rs 199 billion from Rs 166 billion a year earlier. Interestingly, in 2012-13 credit to private sector was a negative Rs 19.2 billion and in FY 2014-15 it was Rs 208.7 billion.

— Excessive borrowings are done without a payment plan, which is a risky affair for a future elected government. This will cause further embarrassment at the time of maturity because the funds are used for interest payment and not utilised for growth purposes.

— A large part of revenue collection is based on Customs Duty and Sales Tax on import, whereas country is heavily reliant on indirect taxes. Therefore, talking on this subject is meaningless unless taxes are imposed on all types of Income. We have to bite the bullet on tax reforms.

— Pakistan’s Economic curse is due to policy shift towards banking sector discouraging Banks not to allocate funds for credit expansion. This forceful austerity helps contain Fiscal Deficit at the cost of growth.

— Credit for higher remittances and containing inflation goes to SBP due to its prudent policy.

— Rising debt is because of Higher Interest Rate Policy and Extremely High Coupon Rate costing nearly Rs 2 trillion. There is a high price that nation has to pay to bring down the deficit. It also discourages economic activity, resulting in low revenue collection. A fall in banking sector’s advance/deposit ratio from 76 percent in 2005 to 51 percent in 2015 will endorse my viewpoint and negate all arguments.

— Circular debt is a pain in the neck, which cannot be avoided through accounting gimmicks, as there is always alteration cost.

— About the misconception that the CPEC will not hit public external debt is true. This I have frequently explained in my various write-ups. But then why is government taking credit for major share of USD 35 billion 15-year deal, which is a private sector power generation deal or unless it has secretly provided guarantees?

Pakistan’s bad luck is that in an increasingly unstable environment various governments only made efforts to stay afloat through various borrowing techniques. Slow growth and rising debt are the lending agencies’ recipe and not a solution to the problem. Emergency measures to bring stability can only provide temporary relief. It’s a Never Ending Math Equation unless real income is generated. Therefore the question that begs answer is: Will the economy ever truly recover?

Copyright Business Recorder, 2016        


Public debt management

March 19, 2016


When the present government started its term in June 2013, it inherited challenges like large fiscal deficit, rising debt burden, unfavourable balance of payments, low foreign exchange reserves, poor growth in tax revenues with shrinking tax-base, swelling current expenditures, a gigantic circular debt that was unravelling the energy sector, flight of capital, weakening exchange rate and perilously declining investors’ confidence. On the external front, the major development partners had considerably scaled down their support due to waning economic fundamentals and apparent inability of the country to service its external obligations in the near future. One of the main challenges was absence of external financing which was causing turbulence in the domestic exchange markets and tilting the composition of public debt towards domestic debt and that too into shorter maturities creating vulnerabilities and entailing high rollover and refinancing risks. State Bank of Pakistan (SBP) forex reserves, which stood at $6 billion in June 2013 fell to $2.8 in February 2014. It was a highly precarious situation for the external account.

In early 2013, it was predicted that the country might default on its sovereign obligations, if necessary steps to avert the situation were not taken. These predictions were made by the financial experts, who had analysed the macroeconomic situation prevalent at that time and reached the conclusion that the country would not have sufficient external resources to meet its obligations of external debt falling due beyond February/June 2014. There was a dire need for stemming the depleting reserves and stabilising a fast depreciating currency, which touched Rs 110.25 against US Dollar on 29 November, 2013, was fuelling inflation and raising the cost of debt servicing. The importance of lengthening the maturity profile of domestic debt became inevitable while maintaining interest rate stability and regaining growth momentum was also required to counter the impact of indebtedness.

On assuming office, the present government took necessary steps for avoiding default, ensuring fiscal discipline and consolidation, stabilising a collapsing economy and accelerating growth. Accordingly, the government started revamping the economy through structural reforms and stabilisation measures such as reduction in un-targeted subsidies, broadening the tax base, restructuring the Public Sector Enterprises (PSEs), building foreign exchange reserves and reducing the fiscal deficit, while ensuring that social safety net and development spending are not only protected but enhanced considerably. A brief account of the improvement in major economic indicators over the period from June 2013 to June 2015 is given below:

FBR revenue increased from the level of Rs 1946 billion in FY2012-13 to Rs 2588 billion in FY2014-15. FBR is on course to achieve the revenue collection target in excess of Rs 3000 billion during the FY2015-16. Budget deficit was contained at 8.2% in FY2012-13 (down from a projected 8.8%) within weeks of assuming office. The deficit has been reduced to 5.3% in FY2014-15. We are on track so far to reduce it to 4.3% for the FY 2016 ending in June 2016. Average inflation reduced from 8.62% in FY2013-14 to 4.53% in FY2014-15. Average CPI during the period July-February of FY 2016 has been recorded at 2.48%.

Credit to private sector, which was negative at Rs 19.2 billion in FY2012-13, increased to Rs 208.7 billion in FY2014-15. During the current financial year 2016, the amount has increased to Rs 299.7 billion till 12th February 2016. Credit to Agriculture sector increased from Rs 336.2 billion in FY2012-13 to Rs 515.9 billion in FY2014-15. The target for the current FY2015-16 is Rs 600 billion. Development spending, which was Rs 348 billion in FY2012-13 increased to Rs 502 billion in FY2014-15. During the current FY2015-16 an amount of Rs 700 billion has been budgeted.

Remittances increased from $13.9 billion in FY2012-13 to $18.7 billion in FY2014-15. During the current FY, $12.7 billion were remitted till the 29th February 2016. The fiscal consolidation paved the way for a reduction in the Debt to GDP ratio, which fell from 64 percent in FY2012-13 to 63.5% at the end of FY2014-15. In the next three fiscal years, our target is to bring down the Debt to GDP ratio to 60% or less in accordance with the provisions of the Fiscal Responsibility and Debt Limitation Act (FRDLA), through effective fiscal and prudent debt management. Debt Management has taken special emphasis in this whole scenario as the absolute debt continues to grow over the last many years due to persistently large fiscal/budget deficits of previous successive governments. Our government’s vision is to further reduce the statutory debt limit from existing 60% to 50% in 15 years, starting from FY2018-19 and to limit statutorily the federal fiscal deficit to 4% through introduction in the Parliament of an amendment bill for necessary changes in the FRDLA in this context.

Despite these achievements, many detractors of the Government are ceaselessly creating doubts about the debt situation of the country. There is, therefore, a need to set the record straight. Pakistan’s total public debt as of 30-06-1999 was Rs 2,946 billion of which domestic public debt was Rs 1,389 billion and external debt was Rs 1,557 billion. Total public debt as of 31-03-2008 was Rs 5,800 billion which included domestic public debt of Rs 3,020 billion and external debt of Rs 2,780 billion. Public debt further increased to Rs 14,318 by the end of FY2012-13; thereby the previous government contracted net debt of Rs 8,518 billion during its term 2008-13.

Pakistan runs a persistent fiscal deficit. For FY2012-13, the country’s fiscal deficit was projected at 8.8% of GDP. It was due to a major effort during the last month of the FY2012-13 that we were able to contain it at 8.2%. Such a high level of fiscal deficit is unsustainable as it adversely affects economic growth and necessitates larger amount of borrowing to meet the fiscal gap.

The present government started its first fiscal year in 2013 with inherited total public debt of Rs 14,318.4 billion comprising of external public debt of $48.13 billion (Rs 4,796.5 billion) and domestic projected at 8.8% of GDP. It was due to a major effort during the last month of the FY2012-13 that we were able to contain it at 8.2%. Such a high level of fiscal deficit is unsustainable as it adversely affects economic growth and necessitates larger amount of borrowing to meet the fiscal gap.

The present government started its first fiscal year in 2013 with inherited total public debt of Rs 14,318.4 billion comprising of external public debt of $48.13 billion (Rs 4,796.5 billion) and domestic public debt of Rs 9,521.9 billion. During the period from July 2013 to December 2015, the total public debt has grown to Rs 18,467.3 billion out of which the external public debt is $53.36 billion (Rs 5,589.2 billion) while domestic public debt is Rs 12,878.1 billion. Thus, there is a net increase of Rs 4,148.9 billion in total public debt, inclusive of $5.23 billion of external debt.

The reason our government was able to achieve a lower level of borrowing was that we kept the fiscal deficit under control by enforcing fiscal discipline. In this context, efforts have been made to achieve lower targets of fiscal deficits in the first 3 fiscal years of our government.

The previous government entered into a front-loaded Stand-By Arrangement with IMF in 2008 with a total loan of $11 billion. A major chunk of the loan amounting to $3089 million was released upfront, followed by four more releases amounting to $4366 million, thereby making total loan disbursements of $7,455 million to previous government. Thereafter, the Stand-By Arrangement was suspended due to inability of the government to implement the agreed economic reforms and as a result the previous government could not draw $3545 million earmarked for the country under the programme.

The present government entered into an Extended Fund Facility (EFF) with the IMF in September 2013 with estimated total amount of $6.6 billion. Till date the inflows from IMF under current program has been $5,271 million while the repayments to IMF in this period amount to $4,415 million, in settlement of the instalments due of the loans taken by the previous government. Therefore net inflow from IMF in our tenure stands at $856 million, which is included in the increase of $5.23 billion recorded in external debt. Government has successfully completed ten quarterly reviews and is on track to complete the reforms program by September 2016. The economic reforms being implemented are home grown and were part of the manifesto of Pakistan Muslim League (N) for general election, 2013 and became basis of IMF current program.

There were two reasons for entering into IMF supported Extended Fund Facility, which is more tedious than other Fund’s facilities. Firstly, the necessity of major repayment of loan taken by the previous government under the Stand-By Facility and secondly, to restart full scale business with other multilateral development partners which had suspended support to Pakistan due to the macroeconomic instability caused by discontinuation of the reforms program in the previous government’s tenure.

Present government has repaid over $10 billion of external debt till end December 2015, which mainly related to the borrowings of the previous governments. Despite this heavy repayment, the foreign exchange reserves of the country have risen to more than $20 billion, of which SBP reserves were $15.8 billion at end December 2015, which is equal to nearly four months of import- cover as compared to less than around 3 weeks of import-cover in February when the SBP reserves stood at $2.8 billion.

It is worth mentioning here that while the external public debt has gone up by $5.23 billion during the two and a half years, the forex reserves of SBP have increased by $9.8 billion in the same period or by $13 billion when compared to from February 2014 to December 2015.

The critical consideration in debt management is the sustainability analyses for which various indicators have been designed. Major debt sustainability indicators have improved in the first two fiscal years, a fact that is acknowledged by global stakeholders. “Refinancing Risk of the Domestic Debt Portfolio” was reduced through lengthening of the maturity profile at the end of June 2015. Percentage of domestic debt maturing in one year was reduced to 47 percent compared with 64 percent at the end of June 2013.

“Exposure to Interest Rate Risk” was also reduced, as the percentage of debt re-fixing in one year decreased to 40 percent at the end of June 2015 compared to 52 percent at the end of June 2013.

“Share of External Loans Maturing within One Year” is equal to around 28 percent of official liquid reserves at the end of June 2015 as compared with around 69 percent at the end of June 2013 indicating improvement in foreign exchange stability and repayment capacity.

Moreover, there is a perception that the major part of forex reserves accumulation has been done by way of contracting expensive external debt, especially Euro Bonds, which again is a patently flawed understanding of the facts. The cost of Eurobonds issued by the government ranges from 7.25% to 8.25%. Pakistan re-entered the international capital market in April 2014 after a gap of seven years to seek additional funding on the basis of its improved macroeconomic indicators in order to avert the predicted June 2014 default of Pakistan. Furthermore a successful capital market transaction helps in opening other vistas for seeking foreign funding and foreign direct investment.

Furthermore, large portion of the forex loans were contracted at extremely low rates and attractive terms. This is evident from the average cost of the total external debt obtained by present government till December 2015 which comes to around 3.3 percent. After including the grants mobilised by the current government, the average cost of borrowing further reduces to 3.03%, which is significantly lower than the domestic financing cost of about 10 percent even after one builds a margin of capital loss due to exchange rate depreciation. Thus cost of the external debt contracted by current government is not only economical but is also dominated by long term funding. To establish the fact that this government has slowed down the pace of debt accumulation, the declining trajectory of Debt to GDP ratio is a sufficient proof.

It is worthwhile to mention here that some quarters are quoting an incorrect number of external public debt. There is a need to understand the difference between External Public Debt and Total External Debt and Liabilities of the country. External Public Debt stood at $53.4 billion, as at end-December while at the same time the total external debt and liabilities of the country were $68.5 billion. Total external debt and liabilities include debt of other sectors which by definition are not considered as public external debt since the government is not liable to pay these obligations. It includes debt of private sector and banks etc.

A misconception commonly spread is that the CPEC will result in increase in public external debt to $90 billion by 2018. This is neither based on facts nor on a proper understanding of debt dynamics. First, a wrong base number of $66 billion is being used to arrive at the $90 billion number. Secondly, out of the total CPEC package of $46 billion, a major share of $35 billion is in the private sector, mostly in power generation in IPP mode, not adding to the external public debt.

Those making such astounding claims seem to lose sight of the fact that while making debt projections, the debt due for repayment during the corresponding period is to be taken into account as well. While new debt is contracted, previously accumulated liabilities are being discharged at the same time.

Another baseless and misleading news was recently run by Bloomberg, which otherwise is a very credible new agency, that Pakistan’s external debt of nearly $50 billion was maturing during 2016. This was an outlandish speculation completely bereft of any truth. Our total external debt is close to this amount and is due to be retired in the next 40 years. Ministry of Finance issued two detailed rejoinders, which were suitably addressed by the Bloomberg.

At a time when we have brought major improvements in debt management it is regretful that some quarters are deliberately sowing seeds of doubt and confusion in ordinary minds. Pakistan has regained the external reputation and financial credibility. This has been unquestionably recognised by international development partners and a number of well-reputed global publications such as Economist, Wall Street Journal, Forbes, etc.

By the grace of Almighty Allah, Pakistan’s economy is showing visible signs of improvement. Having successfully averted the predicted default of June 2014 and having achieved macroeconomic stability, our government is now making efforts to put the economy on a high growth trajectory with a target of 7% by 2018 that would enable significant reduction in poverty and creation of jobs for our youth. The government under the leadership of Prime Minister Nawaz Sharif is determined to consolidate the economic gains achieved so far and to ensure that these translate into increased economic opportunities for the common man.

(The writer is a Senator and the Finance Minister of Pakistan)

Copyright Business Recorder, 2016


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