LAHORE: The successful float of a five-year Eurobond with 8.25% coupon rate has been attributed to continued confidence of international investors, up grading of credit rating to B3 by Moody’s and drum-beating of foreign exchange reserves to meet the requirements of the Extended Fund Facility (EFF) of the International Monetary Fund (IMF).
The government is continuously tapping international debt market to bolster foreign exchange reserves. Policymakers are paying attention to external debt-to-GDP ratio, which is around 25%, and this ratio is considered normal from the standpoint of solvency.
If external borrowing is done to enhance productive capacity of the economy, either to modernise infrastructure or to augment technological progress, it is considered prudent.
Debt for the sake of debt servicing shows that domestic resource mobilisation is not done according to the emerging requirements which in turn increase the gap between expenditure and revenue.
The case of foreign debt is made stronger and is usually propagated on the ground that foreign debt is cheaper than domestic debt and debt servicing cost is being reduced to gain fiscal space. Such statements favour short-term political exigencies at the expense of long-term economic development since political governments take decisions keeping in view their election cycle and are more concerned with day to day functioning.
A significant economic variable ie exchange rate is assumed fixed in this argument. However, a bit of reflection tells that earlier Eurobonds were floated when one dollar was equivalent to around Rs100. The rupee has further depreciated during this short span of time which also brings exchange rate loss to the borrower and makes the Eurobond conundrum.
Regarding debt, an important question needs to be asked: whether a government can default on domestic debt or not? The answer is that a government can never default on the domestic debt since it can borrow from the central bank and enhance its monetary base accordingly.
However, a government can default on to its external debt and commitments. Asian, Latin American and East European peripheral countries are only a few that have defaulted in the past.
The case of Argentina is instructive as it was dragged into the US Supreme Court by private institutional investors after it defaulted. The dispute is still unsettled and Argentina is unable to tap international market and this is a stumbling block in its debt restructuring. In addition, default on the external debt gives rise to unpopular decisions since lenders demand strict actions from the borrowing countries in return of the existing loans which also becomes a threat to fledgling democracies.
The government has resorted to external as well as expensive commercial borrowing which doesn’t suit the low value-added export structure of a developing country.
A developing country’s dollar-earning capacity hinges on its export structure. Being a commodity and low value-added producer, dollar earnings are rather limited in Pakistan since the current export structure is not sophisticated and markets are geographically constrained. On top of that, the precipitous decline of global commodity prices in the last year has further weakened dollar earnings.
In a nutshell, the decision of tapping international debt market requires proper planning by looking at the future streams of income and structural considerations. The focal consideration needs to be liquidity. Historically, Pakistan is sensitive to liquidity crisis as the inability to fulfil obligations to the lenders leads to balance of payment crisis. In this regard, advice from IMF can prove to be instrumental.
The writer is an Assistant Professor of Economics at Lums
Published in The Express Tribune, October 12th, 2015.