Pakistan may continue to breach debt limit for next 10 years

Bank says one of the reasons for breaching the FRDL ceiling could be ambitious fiscal targets

ISLAMABAD: Pakistan may continue to breach the Fiscal Responsibility and Debt Limitation (FRDL) Act even for the next 10 years due to higher expenditures and low revenues, said the World Bank, while urging authorities to prudently manage fiscal operations to limit the debt servicing cost.

The FRDL Act of 2005, which binds the federal government to keep its budget deficit to a prudent level, has also remained a headache for the past two governments of Pakistan Peoples Party (PPP) and Pakistan Muslim League-Nawaz (PML-N). Former finance minister Ishaq Dar amended the FRDL Act twice to paint a rosy picture amid deteriorating debt indicators.



“The country has been in breach of the Act since 2010….If the current trajectory persists, Pakistan is unlikely to be able to comply with this law over the next decade,” said Pakistan Development Update report that the World Bank released early this month.

The country’s debt has already crossed sustainable levels and debt servicing is eating up more than one-third of the budget. However, the World Bank has underlined a critical issue - borrowing by the finance ministry without purpose. The report noted that in the last fiscal year 2017-18, the then federal government paid Rs300 billion in interest only on incremental treasury bills with maturities of less than 12 months.

“However, the federal government alone had cash deposits worth 2.8% of GDP (roughly Rs1 trillion), sitting with commercial banks at the start of fiscal year.” Almost one-third of these deposits pertained to core government ministries, departments and agencies, it added. The bank suggested that the federal government could have tapped into this cash at a time when the market was unwilling to invest in long-term bonds.

The conflict of interest and vested interests in the Q Block were the reasons for not withdrawing these deposits placed with commercial banks at nominal rates, said sources in the Ministry of Finance.

The international lender noted that one of the reasons for breaching the FRDL ceiling could be ambitious fiscal targets. The law requires the federal fiscal deficit to be 4% of GDP from fiscal year 2018 to 2020 and at 3.5% from fiscal year 2021 onwards.

Similarly, the total public debt should be 60% of GDP by FY18 and the debt should be reduced by 0.5% annually from 2019 to 2023 and by 0.75% from 2024 onwards to 50% of GDP by FY33.

As of end-June 2018, the total public debt stood at 73.5% of GDP and a report by the International Monetary Fund (IMF) suggests it will remain above this level in the next three years. Pakistan is scheduled to begin talks with the IMF for another bailout package, which will further increase the debt burden.

A projected Rs2-trillion budget deficit in the current fiscal year and economic slowdown over the next two to three years at least will also push the debt-to-GDP ratio further up, keeping the Pakistan Tehreek-e-Insaf (PTI) government under pressure.

The World Bank said in the last fiscal year there was an increase of 5.6% of GDP in the public debt and almost one-third of the increase came from the depreciation of the rupee against the US dollar.

Commenting on the debt dynamics, the World Bank noted that the share of Chinese debt in the total external debt was also on the rise. Pakistan received a gross $11.4 billion in the last fiscal year and one-third of that debt came from China. Half of these loans were disbursed by Chinese banks on commercial terms.

In a footnote, the bank noted that these were medium-term loans from China that were meant for balance of payments support with an inbuilt bullet repayment feature, a maturity of two to three years and a floating rate based on the London Inter-bank Offered Rate (Libor).



It said disbursements from China surpassed inflows from multi-laterals. However, most of these Chinese loans are front-loaded as debt service payments total $6.6 billion for the next three years, adding to the country’s gross financing needs. The Washington-based lender said rising fiscal deficits over the past two years led to a step-up in borrowing from the domestic market, despite substantial external debt inflows. Due to weakening macroeconomic fundamentals leading to interest rate hikes, the bank did not invest in long-term debt instruments.

As a result, the share of floating debt in the domestic debt increased from 37% in FY16 to 54% by June this year.

The World Bank appreciated the introduction of Pakistan Investment Bonds (PIB) with a 10-year floating rate, saying it could facilitate the lengthening of the maturity profile of domestic debt. The floating-rate PIB is linked with the six-month market treasury bills’ weighted average yield.

Published in The Express Tribune, October 21^st, 2018.

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