Reading Time: 5 minutes While debt, in general, may not be all that bad and many countries borrow a massive amount of money from abroad, it may not be ‘good debt’ if it is taken to ease existing expenditures such as a fiscal deficit or to pay for imports. If Pakistan is unable to increase exports and reduce reliance on imports while at the same time growing the size of the economy, the debt cycle may continue for many more years.
In order to make purchases from abroad (imports), countries need to make payments in foreign currency. In most of the world, payments for goods coming in from abroad are made in the US Dollar (USD), global oil prices are also listed in USD. To make these payments, countries maintain reserves of foreign currency, this is earned by ‘selling’ goods abroad i.e. exports.
When countries do not have sufficient reserves and have to pay for the goods coming from abroad into the country, the country is left with very little options. Stopping imports or reducing them to a level that is affordable is not a short-term option as measures to enact such changes take a long time, additionally, some imports such as oil are often unavoidable.
Then, in order to fix the problem, governments usually have to take external debt to overcome the shortfall. This is the problem that successive Pakistani governments have had to face and were compelled to go to the International Monetary Fund (IMF) or other international lenders for debt.
Facing the same problem again, burdened with the additional need to make interest payments on past loans, in 2019, the newly elected Government of Pakistan had to go to the IMF for a ‘bailout.’ Today, Pakistan’s total national debt equals 72.5% of the total Gross Domestic Product (GDP). This includes all the money that the government of Pakistan has borrowed from local lenders/banks and also international financiers such as the IMF, it does not include the money borrowed by provincial governments, local governments or government agencies directly; so the total national debt may as well be at an even higher figure. Such figures on cursory glance seem very troubling, even logically borrowing more to pay back past debt sounds like an idea destined for failure. But what is the economics behind this?
Borrowing money from abroad to make up reserves and to carry on expenditure is not really a phenomenon unique to Pakistan. All economies in the world, from the most advanced industrial economies, like the United States (US) and Japan, to those endowed with vast natural resources, like Saudi Arabia and Venezuela, borrow money. There is nothing wrong with a country floating bonds, financing infrastructure projects through long-term debt instruments, and using capital markets, both domestic and external, to meet its financing needs. So this begs the question, why do other ‘developed’ economies which are heavily geared not face the problems that Pakistan faces?
The total national of the United States is upward of 22 trillion USD, a whopping 76.4% of their GDP. China’s total national debt is equal to 5.2 trillion USD, which amounts to 47.6% of its total GDP.
Governments finance debt by usually issuing bonds in the international market which other countries or international organizations would have to buy and therefore giving money to the issuing nation who would, in turn, pay them interest. Some government bonds are seen as riskier than others. A country’s external debt may be viewed as unsustainable relative to its GDP or its reserves, or a country could otherwise default on its debt. It may be sustainable to borrow more and more money if there exists a strong export sector within the economy which would generate enough wealth to be able to pay back the loans.
China has a massive manufacturing sector which drives its expansive export sector. While they have over the years and continue to borrow money to fund infrastructure or finance budget deficits, China continues to generate/earn enough foreign currency to be able to sustain such a borrowing pattern while also take advantage of the money by growing larger. The case for the US is slightly different, while they too have a strong export sector but what is more powerful is the fact that their currency, the USD is the global reserve currency.
Most international trade happens in the USD, especially oil. Most countries around the world even choose the USD to be ‘the’ currency for their foreign reserves. The US is able to print money without much financial trouble as the dollar continues to be most demanded currency globally, there would always be countries willing to buy it – they have to if they want to purchase crude oil. Broadly speaking, US debt is an in-demand asset. It is safe and convenient.
Which is why countries like China and Japan ‘buy’ US debt. The idea that the US owes China over 1 trillion USD and that allows China massive power over the US isn’t really true. Even if, China wishes to recall that debt, many countries around the world would be willing to ‘buy’ the debt. Holding US debt simply means that the country is holding US Treasury issued bonds, which itself can be used to pay for imports or just simply exist within the country’s foreign currency reserves.
Pakistan over the years has found its export sector to be declining with imports rising. Many inputs that go into the limited manufacturing sector in Pakistan are also often imported, which negates the net positive impact that exports bring to the economy. See can Lahore and Islamabad overtake Karachi?
In the long term, the government needs to also reduce the Pakistani consumer’s reliance on goods coming in from abroad and switch to local substitutes when present while at the same time incentivize and support the export sectors of the economy to grow.
Even on a micro-level, a business organization that borrows money is expected to use that money to grow their operation and make a greater amount of profit in the future. If the firm simply used that money to fund existing expenditure e.g. to pay salaries; they would be unable to pay back the loan in the future.
The current government has gone on a massive drive to ‘document’ the economy and eventually increase the tax base, to earn more tax revenue. Value-added tax has been increased and the Pakistani rupee has been allowed to depreciate, this has made goods more expensive – especially imported products. This has reduced the current account deficit significantly, putting a dent in the oft-repeated ‘twin deficit.’ To put it very simply, if people stop consuming imported products (because they are too expensive) and more people abroad start buying Pakistani goods (textile, fruit for example) because they become cheaper due to the Rupee devaluation; Pakistan finds less pressure on its foreign reserves.
Twin deficit: An oft-repeated term in Pakistani media. It means that the government is running a deficit on the current account (more imports and exports) and also on the budget (spending more than earning).
While debt, in general, may not be all that bad and many countries borrow a massive amount of money from abroad, it may not be ‘good debt’ if it is taken to ease existing expenditures such as a fiscal deficit or to pay for imports. If Pakistan is unable to increase exports and reduce reliance on imports while at the same time growing the size of the economy, the debt cycle may continue for many more years.
Comparisons to economic giants such as the US and China, however, don’t sound all that fair. Uzair Younis compares Pakistan’s debt profile with that of Bangladesh, perhaps a fairer comparison. It is an apt comparison because it has a shared history with Pakistan and was, in fact, less developed than the latter when it emerged as an independent nation. Bangladesh also has a historically low tax-base like that of Pakistan and has had a long period of political instability and yet it continues to grow at a faster pace than Pakistan. Bangladesh’s debt-to-GDP percentage is 25.9% compared to Pakistan 72.5%.
This is where the answer lies, Bangladesh has been able to experience growth and has not been forced to borrow more than it can grow due to a rising export sector (it has, in fact, undercut Pakistan’s global share of textile exports).
Broadly speaking, taking more debt is not necessarily the problem, but the way that the economy is structured is what is the problem. It is not just about greater tax revenue and corruption, but also about providing supportive economic policies and the relevant infrastructure to push for economic growth in the long term. A better-skilled workforce (especially in technical skill) and the provision of stable, continuous and equitable government assistance to growing sectors can perhaps be the key to break the cycle of debt. It is unlikely that 2019 will be the last time Pakistan ended up at the doors of the IMF, but that’s okay, as long as the subsequent steps are used in a way to take it closer to the last time.
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