It is the only segment of the budget which the government is required to spend on by law: the government will spend Rs1.1 trillion – or more than one third of its total outlay – on servicing both the domestic and foreign debt.
Contrary to populist rants against foreign lenders, the overwhelming bulk of the debt servicing is actually just interest on the domestic debt. The government estimates it will have to pay Rs845 billion in interest on its various rupee-denominated debt, though this amount may increase or decrease depending on interest rates. The interest on the domestic debt accounts for nearly three-quarters of the expected government spending on debt servicing.
The vast majority of Pakistan’s domestic debt is held by local banks, pension funds, asset management companies and insurance companies. Hence, the beneficiaries of these massive interest payments on the domestic debt go to the more than 15 million Pakistanis with a savings account, or the millions more pensioners. (It also helps pay the salaries of virtually everyone working in Pakistan’s financial services sector.)
Pakistan is scheduled to make large repayments on foreign loans this year, including $1.2 billion to the International Monetary Fund. Total repayments of the foreign debt come in at approximately Rs216 billion ($2.3 billion) for the fiscal year ending June 30, 2013.
Compared to domestic debt, interest payments on foreign debt are expected to be relatively miniscule. The finance ministry expects to pay out Rs80 billion ($851 million) in interest payments on the foreign debt, which amounts to an average interest rate of 1.7% on a total foreign debt now exceeding $53 billion.
By contrast, the average interest paid by the federal government on its domestic debt comes to around 11.7%. As of the end of March, the total domestic debt of the federal government stood at Rs7.2 trillion ($77.5 billion).
Revenues, not debt, the problem
Despite the astounding numbers, Pakistan’s debt is not especially high, clocking in at 58.2% of the total size of the economy. This level is considered healthy even by the staunchly fiscally conservative Bundesbank (the German central bank). The problem is not in the level of debt, but rather the fact that the government does not raise enough revenues.
The government’s debt servicing costs come to about 35% of the total budget. But that is because the government collects so little in revenues that its budget is very small compared to the whole economy. Indeed, last year, the so-called bloated federal budget came to only 13.4% of the gross domestic product. The debt payments as a percentage of GDP came to about 4.7% last year and will likely be only slightly higher this year.
And the debt servicing payments are not growing at a particularly alarming pace either. Between fiscal year 2009 and fiscal year 2013, the government’s debt servicing payments have increased at an average rate of 11% per year, which is lower than the 11.4% per year average inflation during that period.
Shorter duration of debt
Another problem that the government is facing is the fact that the overwhelming majority of its debt is now short-term. Nearly 55% of the government’s debt has a tenure of one year or less, a dramatic shift from ten years ago when it constituted just over 31% of the government’s debt.
This continuous shortening of the debt has several consequences but is fundamentally a vote of no-confidence by Karachi’s bond market in the government’s fiscal policies. Institutional investors are refusing to invest in longer durations of the government’s debt unless it offers a substantially higher interest rate, which the government is not willing to do.
Investors typically align their interest rate requirements on government securities with their expectations of inflation. In effect, the bond market is betting that the government’s fiscal policies will cause a sharp rise in the already high inflation, which in turn will push interest rates further upwards in the future.
The government has been claiming that it is curbing its expenses and reducing inflation, bringing it down to 11% in 2012 and claiming it will bring it down even further to 9.5% in fiscal 2013.
Published in The Express Tribune, June 2nd, 2012.
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