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Opinion The rising debt burden
Thursday, January 13, 2011
Dr Muhammad Yaqub
According to the Annual Report (2009-2010) of the State Bank of Pakistan, Pakistans total public debt increased from Rs4,896 billion at the end of June, 2007 to Rs9,106 billion at the end of June, 2010, almost doubling in three years. Assuming that the total population of Pakistan is 166 million, every Pakistani citizen was burdened with government debt of Rs54,855, about 44 per cent of which was due to be paid in foreign exchange to foreign governments and agencies.
On debt servicing the situation was even bleaker. Debt servicing has become the largest single item of expenditure in the government budget reflecting the combined impact of increase in the volume of domestic and foreign debt, rise in domestic interest rates and depreciation of the rupee. Debt service payments constituted about half of the total current expenditure and consumed about three fourths of gross tax revenues. The amount spent on debt servicing was about three times larger than defence expenditure. It is obvious that debt servicing has now risen to such a high level of current expenditure, and tax revenue has sunk to such a low proportion of GDP, that there is not much manoeuvrability left with the government to effect improvements in the social and economic welfare of the people or to undertake vital development projects except through further resort to borrowing.
The political leadership and public have not as yet grasped the gravity of the situation partly because the Ministry of Finance has kept them in the dark through window dressing of budget documents. For example, external and internal borrowing is labelled in the budget as external resources and internal resources respectively, and the budget does not explicitly show that government current expenditure is by now far in excess of total revenue, requiring borrowing even to carry out its day-to-day activities.
From an economic point of view, borrowing in itself is not good or bad. It is the use and level of it that make it so. If, like in the private sector, borrowing is kept within manageable limits and used to build capital base and increase production, it could generate enough income to pay back the debt as well as to leave a surplus. However, public sector borrowing is wasted on unproductive consumption expenditure, and some of it is siphoned off through corruption and misappropriation.
Increase in debt burden without a corresponding expansion of the revenue base and of exports has lead to a high rate of inflation and balance of payments difficulties. More borrowing will only extenuate these problems. Therefore, it is imperative that a sensible debt management strategy is adopted to address this growing menace. Such a strategy needs to have the following elements:
First, the present practice of rubber stamping by legislators of the budgets produced by the executive branch must be replaced by their careful scrutiny and approval. The executive branch of the government, both at the centre and in provinces, should be bound through legislation by respective assemblies to keep their internal and external borrowing within the annual limits carefully set by them. The assemblies should set such limits after proper scrutiny of the revenue resources and expenditure plans at all government levels and the balance of payment outlook for the country. More importantly, governments should make a quarterly report to their respective assemblies and to the public in general to confirm adherence to such limits. Additionally, resort to inflationary financing of the budget should be limited by the SBP by using effectively its existing legal authority to determine and enforce government borrowing from it and this authority should not be taken away from the SBP under any pretext, giving Ministry of Finance more elbow room to force the SBP to print more currency notes.
Second, the government at all levels must cut its wasteful consumption expenditure to create space for development activities financed from public savings. There is no justification for keeping on government pay role a herd of ministers, advisers and ambassadors whose marginal productivity is negative for the country. Careless spending on foreign trips, lavish parties and extravagant inauguration functions at government expense need to be stopped. Similarly, import of expensive bullet proof cars and other equipment for the protection of those at the helm of affairs cannot guarantee their security as much as a serious effort to eradicate poverty, reduce unemployment, and minimise frustration and anger of the rest of the population against the conspicuous life style of the ruling elite.
Third, the government should undertake major tax reform to improve the direct tax base, increase tax elasticity and improve tax equity. At present, the government relies heavily on indirect taxes which are inflationary in their impact and regressive by their nature.
The government of the rich, by the rich and for the rich has not been willing to broaden the direct revenue base where taxes can be collected according to the ability to pay and can be so restructured as to promote horizontal and vertically equity. Horizontal equity means that people at the same income level must pay similar taxes regardless of the source of their income. Vertical equity means that marginal rates should rise with rise in income so that richer people pay proportionately more taxes than the poor ones. In Pakistan both of these sound taxation principles are violated, making it one of the most regressive and inelastic tax system in the world. At the same time concrete policy measures may be adopted to reduce the size of the underground economy which is reported to have become equivalent to about 55(of what?????) of recorded economy and remains beyond the reach of tax net.
Fourth, all proceeds from the sale of national assets should by law be mandated to be used only for retirement of the expensive domestic debt and not wasted on additional expenditure. If privatisation proceeds were used for this purpose in the last two decades, domestic debt serving would have declined significantly opening up fiscal space for larger development programs financed from own resources.
Fifth, inflation has contributed to rising debt servicing both through higher nominal interest rates and depreciation of the rupee. Control on inflation is essential not only to protect the poor but also to spare the budget from rising debt servicing that is caused by inflation.
Finally, the government should throw away its begging bowl and replace it by austerity in expenditure and sound economic planning to achieve self reliance and restore national pride. The country should use its frontline status in the war against terror to seek debt relief, debt write off and grants from donors who benefit from sacrifices of the people and soldiers of Pakistan, rather than to get more interest bearing loans which add to the long run debt servicing and balance of payments problems.
Whatever combination of measures is adopted one thing should be clear. Unlike in the past, debt servicing cannot, and should not, be financed by incurring more debt if further damage to the economy and stability and sovereignty of the country are to be avoided.
The writer is a former governor of the State Bank of Pakistan
Thursday, January 13, 2011
Dr Muhammad Yaqub
According to the Annual Report (2009-2010) of the State Bank of Pakistan, Pakistans total public debt increased from Rs4,896 billion at the end of June, 2007 to Rs9,106 billion at the end of June, 2010, almost doubling in three years. Assuming that the total population of Pakistan is 166 million, every Pakistani citizen was burdened with government debt of Rs54,855, about 44 per cent of which was due to be paid in foreign exchange to foreign governments and agencies.
On debt servicing the situation was even bleaker. Debt servicing has become the largest single item of expenditure in the government budget reflecting the combined impact of increase in the volume of domestic and foreign debt, rise in domestic interest rates and depreciation of the rupee. Debt service payments constituted about half of the total current expenditure and consumed about three fourths of gross tax revenues. The amount spent on debt servicing was about three times larger than defence expenditure. It is obvious that debt servicing has now risen to such a high level of current expenditure, and tax revenue has sunk to such a low proportion of GDP, that there is not much manoeuvrability left with the government to effect improvements in the social and economic welfare of the people or to undertake vital development projects except through further resort to borrowing.
The political leadership and public have not as yet grasped the gravity of the situation partly because the Ministry of Finance has kept them in the dark through window dressing of budget documents. For example, external and internal borrowing is labelled in the budget as external resources and internal resources respectively, and the budget does not explicitly show that government current expenditure is by now far in excess of total revenue, requiring borrowing even to carry out its day-to-day activities.
From an economic point of view, borrowing in itself is not good or bad. It is the use and level of it that make it so. If, like in the private sector, borrowing is kept within manageable limits and used to build capital base and increase production, it could generate enough income to pay back the debt as well as to leave a surplus. However, public sector borrowing is wasted on unproductive consumption expenditure, and some of it is siphoned off through corruption and misappropriation.
Increase in debt burden without a corresponding expansion of the revenue base and of exports has lead to a high rate of inflation and balance of payments difficulties. More borrowing will only extenuate these problems. Therefore, it is imperative that a sensible debt management strategy is adopted to address this growing menace. Such a strategy needs to have the following elements:
First, the present practice of rubber stamping by legislators of the budgets produced by the executive branch must be replaced by their careful scrutiny and approval. The executive branch of the government, both at the centre and in provinces, should be bound through legislation by respective assemblies to keep their internal and external borrowing within the annual limits carefully set by them. The assemblies should set such limits after proper scrutiny of the revenue resources and expenditure plans at all government levels and the balance of payment outlook for the country. More importantly, governments should make a quarterly report to their respective assemblies and to the public in general to confirm adherence to such limits. Additionally, resort to inflationary financing of the budget should be limited by the SBP by using effectively its existing legal authority to determine and enforce government borrowing from it and this authority should not be taken away from the SBP under any pretext, giving Ministry of Finance more elbow room to force the SBP to print more currency notes.
Second, the government at all levels must cut its wasteful consumption expenditure to create space for development activities financed from public savings. There is no justification for keeping on government pay role a herd of ministers, advisers and ambassadors whose marginal productivity is negative for the country. Careless spending on foreign trips, lavish parties and extravagant inauguration functions at government expense need to be stopped. Similarly, import of expensive bullet proof cars and other equipment for the protection of those at the helm of affairs cannot guarantee their security as much as a serious effort to eradicate poverty, reduce unemployment, and minimise frustration and anger of the rest of the population against the conspicuous life style of the ruling elite.
Third, the government should undertake major tax reform to improve the direct tax base, increase tax elasticity and improve tax equity. At present, the government relies heavily on indirect taxes which are inflationary in their impact and regressive by their nature.
The government of the rich, by the rich and for the rich has not been willing to broaden the direct revenue base where taxes can be collected according to the ability to pay and can be so restructured as to promote horizontal and vertically equity. Horizontal equity means that people at the same income level must pay similar taxes regardless of the source of their income. Vertical equity means that marginal rates should rise with rise in income so that richer people pay proportionately more taxes than the poor ones. In Pakistan both of these sound taxation principles are violated, making it one of the most regressive and inelastic tax system in the world. At the same time concrete policy measures may be adopted to reduce the size of the underground economy which is reported to have become equivalent to about 55(of what?????) of recorded economy and remains beyond the reach of tax net.
Fourth, all proceeds from the sale of national assets should by law be mandated to be used only for retirement of the expensive domestic debt and not wasted on additional expenditure. If privatisation proceeds were used for this purpose in the last two decades, domestic debt serving would have declined significantly opening up fiscal space for larger development programs financed from own resources.
Fifth, inflation has contributed to rising debt servicing both through higher nominal interest rates and depreciation of the rupee. Control on inflation is essential not only to protect the poor but also to spare the budget from rising debt servicing that is caused by inflation.
Finally, the government should throw away its begging bowl and replace it by austerity in expenditure and sound economic planning to achieve self reliance and restore national pride. The country should use its frontline status in the war against terror to seek debt relief, debt write off and grants from donors who benefit from sacrifices of the people and soldiers of Pakistan, rather than to get more interest bearing loans which add to the long run debt servicing and balance of payments problems.
Whatever combination of measures is adopted one thing should be clear. Unlike in the past, debt servicing cannot, and should not, be financed by incurring more debt if further damage to the economy and stability and sovereignty of the country are to be avoided.
The writer is a former governor of the State Bank of Pakistan
