Pakistan’s long history of fiscal mismanagement has saddled the country with a crushing debt burden. Interest payments on the public debt consume a staggering 60% of government revenue. And external-debt repayments coming due over the next five years amount to nearly $70 billion, dwarfing the $11 billion in foreign-exchange reserves held by the central bank.
No wonder that some experts have started calling for a default and restructuring. Many others are still urging strict adherence to the three-year austerity program approved by the International Monetary Fund in September to balance the books. Neither default nor austerity is likely to work, however, and both would inflict unnecessary pain.
External debt restructuring is the wrong medicine for Pakistan, because the problem is not the external interest burden but rather the volume of repayments falling due. Only 10% of interest payments go to private creditors, given that almost all – more than 85% – of Pakistan’s external debt is owed to official creditors at concessional rates. So, even if the Pakistani government stopped paying interest to external private creditors altogether, this would barely make a dent in its overall bill.
Around half of Pakistan’s public-debt stock is owed to multilateral creditors such as the IMF and the World Bank, and thus cannot be restructured unless these institutions launch a new debt-relief scheme like the Heavily Indebted Poor Countries (HIPC) Initiative of the 1990s. And with remaining obligations to bilateral creditors (mainly China, Saudi Arabia, and the United Arab Emirates) already being rolled over under the IMF program, halting repayments would provide little benefit and could entail high costs in terms of damage to diplomatic and trade relations and access to future financing.
Restructuring domestic debt, on the other hand, could lower Pakistan’s interest bill, but would cause severe economic pain. Nearly two-thirds of the government’s domestic obligations are held by banks, where these securities comprise around 60% of assets.
Even a modest haircut of 10% would wipe out the banking system’s capital, though the impact would vary from institution to institution. Banks would be unable to repay depositors, triggering financial turmoil and a sharp economic contraction.
If restructuring won’t help, what about the new IMF austerity program, which seeks to increase the tax-to-GDP ratio by three percentage points over three years? To be sure, addressing the country’s chronic revenue shortfalls is of paramount importance. Only around 1% of Pakistanis pay any income tax at all, and the government’s revenue collection – at around 12% of GDP – is among the world’s lowest.
The agriculture, retail, and real-estate sectors, which constitute the bulk of the economy, are effectively outside the tax net. No country can function like this.
But the IMF program aims to raise the tax-to-GDP ratio by two percentage points in the first year alone – a breakneck pace that is wildly unrealistic. Pakistan has never achieved an adjustment of this scale in a single year. Even if, by some miracle, the government did manage it, the negative effects on economic activity and poverty rates would be crippling.
Nor is any relief in sight on the spending side. The government’s non-interest spending relative to GDP is to be held below its average level over the past decade, which was already among the lowest of the world’s emerging economies and insufficient to meet basic development needs. Even if this austerity could be achieved, its social and political sustainability is far from assured.
In short, restructuring is bad medicine, and the IMF program is good medicine, albeit at a lethal dose. But there is a third way.
For starters, the Pakistani government must raise tax revenue by 1% of GDP annually over five years by implementing aggressive structural reforms to broaden the tax net.
Policymakers should channel half of the gains back into the economy through increased spending on education, health care, poverty eradication, and climate-resilient infrastructure.
During this reform process, bilateral and multilateral creditors should temporarily extend new loans to Pakistan, instead of just rolling over the debt coming due. Liquidity relief would boost economic growth by increasing public investment and crowding in private investment. To ensure that these funds are well spent, creditors must condition their lending on reform progress and be involved in selecting and implementing public investment projects.
Lastly, to facilitate coordination, the IMF should regularly publish data on actual and projected loan flows and interest paid to each major official creditor. This information is currently not available. A creditor will be more likely to provide new concessional lending if it knows that other creditors are doing so as well.
In its current form, the austerity program will almost certainly fail, causing Pakistan’s economic conditions to deteriorate further and delivering a reputational hit to the IMF. But if policymakers reduce the dose now, and creditors provide more liquidity by enhancing coordination, Pakistan is more likely to grow out of its debt problem. Such an approach could then be broadened to address debt overhangs in other emerging economies. Copyright: Project Syndicate, 2024
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