National Debt: Security Implications

Developing countries get loans from International Monetary Fund (IMF) and multilateral agencies in order to cover budget deficit and for development of the country. The external loans should not surpass 75 percent of total GDP and 350 percent of total export earnings. Otherwise, the sovereign would be considered a defaulter. Therefore, the debt should be used efficiently in order to get maximum benefits from it. In case of Pakistan, Government revenue deficits and development projects are constantly plugged through foreign loans, which mean that the foreign loans will invariably grow to dangerous levels someday. The foreign borrowing in the last five years has doubled the volume of total foreign debt. The rate of borrowing foreign debt to plug government expenditures and finance projects has increased many times.

A persistent deficit in the revenue account of the federal budget over the past three decades has posed serious problems for the macro economy of the country. According to the State Bank, Pakistan’s total external debt crossed 69,559 million US dollars, which is increasing with an alarming rate of 11.6 percent annually. This whopping ratio is likely to increase Pakistan’s total debt to 90 billion US dollars in the next three to four years and the country will need 20 billion US dollars annually to meet repayments. In the same month of last year the external debt was 63,994 million US dollars. This means that the government has borrowed 5565 million US dollars in one year. Currently, the government is in debt of 13,188.1 billion Rupees by domestic lenders.

The total debt of Pakistan is 65.7 percent of the total GDP of the country. Since 2008, Pakistan has borrowed 28859 million US dollars from external sources. On the other hand the two democratic governments have borrowed 13005 billion Rupees in last seven years from internal sources. Moreover, the government is not including China Pakistan Economic Corridor (CPEC) loans in total public debt. The inclusion of CPEC loans would further add 1400 million US dollars in the total debt of the country. However, Government officials believe that significant increase in exports. The increase in exports would decrease external debt. They consider increase ration in GDP as an economic gadget showing growth of a country at macro and micro level.

The aforementioned debate raises the question that when Pakistan expected to enter into the danger zone as far as loans repayments are concerned? The debt to revenue ratio of Pakistan is already very high and has entered into the danger zone. The debt to revenue ratio is usually limited to 350 percent for a state, beyond which it wouldn’t be sustainable for any country to repay the loans installments. Unfortunately, the current debt to revenue ratio of Pakistan stands at an alarming proportion of 270.1 percent, which is increasing annually. Increase in oil prices in international market would further increase this ratio.

On the other hand, unfortunately, Pakistan’s ability to repay loans will be achieved through a combination of better tax collection, increase in export earnings and tight public expenditure controls. In this regard, tax reforms are inevitable. Fiscal deficit would remain increasing with the passage of time unless the government does not create a culture of taxation. The cost of concession and exemption of tax is 900 billion rupees per annum. The current government started a process of elimination and curtailment of exemptions in the budget 2014-15. Approximately 33 percent of these concessions have been withdrawn and rationalized. In fiscal year 2015-2016, a second phase of the plan of rationalization of concessionary regime in-depth deliberations and wide-ranging consultations for minimizing the remaining concessions has started. Exemptions and concessions relating to customs, sales tax and income tax amounting to 120 billion rupees are proposed to be withdrawn. This historic achievement has been recognized and appreciated by all national and international economists. However, there is a need to further expedite this rationalization of concessionary regimes process. Often, political governments face severe pressure from the interest groups in this regard. Therefore, government should complete this process before the election year.

There were one million tax payers registered in 2007. However, this number had decreased to 700,000 in 2013 due to undesired tax exemptions. However, the current government has widened the tax net and the active tax payers’ number once again is almost one million. The Second Schedule of Tax Ordinance provided legal cover to people who had reduced the number of tax payers in the country. The current government has introduced ‘The Second Schedule (Amended Bill 2015-16), which omitted or deleted 19 clauses of actual ordinance. The amended bill would also further reduce the budget deficit, if strictly implemented.

There is a dire need to reset development priorities. Tight public expenditure control can further increase Pakistan’s ability to repay external debt. However, the government seems to take highways as its top priority. The government had reduced the allocation of budget to water and power in the budget 2014-15. There were 38 percent funds of Public Sector Development Programme (PSDP) allocated in the previous budget, however, this year the government was spending 30 percent PSDP on water and power while highways were receiving almost double as compared to water and power. As mentioned above, the improvement in the ability of government to debt repayments is largely based on increase in export earnings. If the government would remain unable to provide sufficient electricity, production houses will move to neighbouring countries like Bangladesh and China, who offer more favourable work conditions. Resultantly, Pakistan’s export earnings would not increase to satisfactory level. Furthermore, on average it takes twice the originally projected time and almost twice the originally estimated cost to complete a development project. This practice needs to be discouraged. Moreover, control on corruption is also very important. It is a positive development that since 2013, people have not witnessed any mega corruption scandal. Transparency International also improved the ranking of Pakistan. National Accountability Bureau (NAB) has been active since 2014. The ongoing operation against corruption needs to be further accelerated in order to further reduce the budget deficit of the country.

The aforementioned debate concludes that the government’s ability to repay loans would likely to remain weak in next few years as Pakistan lacks the culture of paying taxes. Moreover, political compulsions create hindrances in the growth of revenues. For instance, the government had tried to impose 0.6 percent transaction tax on business community in fiscal year 2015-16. Business community reacted on government’s decision and later government was compelled to reduce the tax to 0.3 percent. However, if government strictly implements its taxation policies and improves efficiency in public expenditures than this grim situation may be improved in next few years.

In this backdrop, what are possible ramifications and consequences for the national security of the country, if Pakistan is not able to repay these loans? The ramifications of such crisis may likely to cover political, economic, defence and social sectors. Some consequences of extraordinary debt burden are as follow:

Political ramification may include the political instability in the country. People would lose confidence in political leadership, which would have severe political turmoil. The political turmoil is detrimental to economic growth particularly in the field of Foreign Direct Investment (FDI). It may accelerate the road to severe economic crisis as the world has witnessed in case of Greece. Foreign loans come with harsh terms from the lenders. The lenders are justified in fixing their terms, because they want to ensure that the loan is paid back. These terms are willingly or unwillingly accepted whole heartedly by governments at receiving end, sometimes at the expense of economic growth and intensified inflation. The cost of living and cost of doing business are severely affected by such terms of lenders, which discourage the business activities in the country. Often, neighbouring countries and countries having stakes offer a bailout package in these economic hard times. These bailout packages are with certain political, strategic and economic conditions.

Economic and social ramifications may include that foreign banks shall refuse to accept Pakistani Letters of Credits (LC) or financial commitments. A (LC) is a sort of guaranteed document from a bank which assures that a seller will receive complete payment after completion of all delivery conditions. If the purchaser couldn’t pay complete payment, the bank would pay all payments. It means that Pakistan will not be able to buy oil and other necessary import items. Resultantly, it would run out of oil in a matter of few weeks. If that happens, the entire transport and air system will come to a halt from Khyber to Karachi. Economists call it an ‘economic doomsday’. Major projects, most importantly CPEC would face severe adverse impact. Political, strategic or defence related ramifications may likely to include the increased pressure by the countries who would offer bailout package for rolling back of Pakistan’s nuclear programme, signing of Non Proliferation Treaty (NPT), Fissile Material Cut-off Treaty (FMCT), Comprehensive Test Ban Treaty (CTBT), compromising on foreign policy, policy change on Kashmir dispute or an adoption of a submissive policy towards India.

To conclude the debate, there are competing narratives in academic circles of Pakistan over debt issue of the country. Some economists believe that Pakistan will never fall to such a low level. However, there is a realization among another school of thought that Pakistan is heading towards a severe economic crisis. In case Pakistan would not be able to repay loans, the internal stability, the campaign against extremist forces, the defence and economy at large will be the prime victims and neighbours as well as regional states including China will not likely be generous enough to offer a bailout package to rebuild the economy. If any other country would offer help, it would likely to bring that offer with extreme conditions.

 

Pakistan Observer, July 27, 2016

Views expressed are of the writer and are not reflective of IPRI policy.

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About the Author

Mr. Khurram Abbas is Assistant Research Officer (ARO) at Islamabad Policy Research Institute. He holds MPhil degree in International Relations from National Defence University (NDU), Islamabad. He is doing his PhD in Peace and Conflict Studies (PCS) from Centre for International Peace and Stability (CIPS), NUST, Islamabad and his thesis is “Role of Social Media in Radicalization Process: Analysis of Muslim World with Particular Reference to Pakistan". His area of interest includes, Perception Management, Role of Social Media, De-Radicalization Strategies, Counter Violent Extremism, Religious Extremism in South Asian region with particular emphasis on India, Afghanistan and Pakistan. Mr. Abbas regularly participates in National and International Conferences. He undertakes extensive research and regularly contributes in academic research journals and national/international dailies. Email: khurram306pcips@nipcons.nust.edu.pk

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