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Monday, November 19, 2012

Fiscal Policy and Debt Management in Pakistan.


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Q#) Major Problem with Fiscal Policy and Debt Management in


Pakistan.
Fiscal Policy and its Problems
Fiscal policy is the use of government spending and TAXATION to influence the economy.
When the government decides on the goods and services it purchases, the transfer
payments it distributes, or the taxes it collects, it is engaging in fiscal policy. The primary
economic impact of any change in the government budget is felt by particular groupsa
tax cut for families with children, for example, raises their disposable income.
Discussions of fiscal policy, however, generally focus on the effect of changes in the
government budget on the overall economy. Although changes in taxes or spending that
are revenue neutral may be construed as fiscal policyand may affect the aggregate
level of output by changing the incentives that firms or individuals facethe term fiscal
policy is usually used to describe the effect on the aggregate economy of the overall
levels of spending and taxation, and more particularly, the gap between them.
Pakistans fiscal profligacy has been in the news for the last five years. All those who
have an interest in Pakistans economy have been writing on this issue and highlighting
the importance of fiscal discipline in preventing macroeconomic imbalances as well as
achieving a full growth potential. The government, on the other hand, appears to be
least interested in pursuing a sound and disciplined fiscal policy. Hence, the rot
continues in terms of low economic growth, stagnating job creation, increased poverty,
higherinflation and more debt.
Every government typically aims at promoting strong and sustainable economic growth
with a view to creating employment opportunities and lasting poverty reduction. This
must probably be achieved by pursing a sound and disciplined fiscal policy. This fact
may not be known to the political leadership, but it is assumed that the economic team
of every government knows the importance of fiscal discipline for the economy. If the
economic team members do their job honestly and urge their political leadership to
pursue a disciplined fiscal policy, things would move differently.
A rule-based fiscal policy has generally been associated with improved fiscal
performance and debt sustainability. Over the past several decades, there has been
increasing acceptance worldwide that fiscal discipline over a prolonged period is

essential for maintaining macroeconomic stability. There also exists a general


consensus that a prolonged commitment to fiscal discipline can only come from a rulebased fiscal policy. Fiscal rules basically represent constraints, and prevent the
government from taking a fiscally irresponsible route.
International experience suggests that countries, which have adopted well-designed
fiscal rules and implemented them effectively, have garnered important credibility gains,
greater electoral support, and achieved higher economic growth on a sustained basis.
Fiscal rules aim to prevent governments from taking short-sighted measures in the light
of election cycles and competing demands from special interest groups, by binding
policymakers to a fiscally prudent path.
Pakistan has experienced serious macroeconomic imbalances in the 1990s mainly on
account of its fiscal profligacy (budget deficit as percentage of the GDP has averaged
almost 7.0 percent per annum), and has accordingly paid a heavy price in terms of
slower economic growth, rising debt burden, and the rise in poverty. It is against this
backdrop that work on a rule-based fiscal policy was initiated in 2001-02. After one year
of hard work and wide-ranging consultation in all the four provinces, a rule-based fiscal
framework was prepared in 2002-03. This framework was enshrined in the Fiscal
Responsibility and Debt Limitation (FRDL) Act 2005, and was passed by parliament in
June 2005.
The purpose of the Act was to inject fiscal discipline in the country. This Act ensures
responsible and accountable fiscal management by all governments, the present and
the future, and would encourage informed public debate about fiscal policy. It requires
the government to be transparent about its short and long-term fiscal intentions and
imposes high standards of fiscal disclosure.
There are five key elements of the law. Firstly, beginning from July 2003 (2003-04),
Pakistans public debt would not be more than 60 percent of the GDP by end June 2013
(2012-13). In other words, Pakistans public debt had to be reduced from 75 percent to
60 percent of the GDP in ten years. Secondly, every year the government would reduce
public debt by at least 2.5 percentage points of the GDP during the ten year period.
Thirdly, revenue deficit (total revenue minus total current expenditure) would be
eliminated by 2007-08 and a surplus would be maintained thereafter. Fourthly, the
government would not provide guarantee to the borrowings of the Public Sector
Enterprises (PSEs) by more than two percentage points of the GDP in a given year.
Fifthly, social sector and poverty-related expenditures would not be less than 4.5
percent of the GDP for any given year, and the expenditure on education and health
would be doubled in terms of percentage of the GDP in ten years.
As can be seen from the above, the law binds the government to pursue a sound and
disciplined fiscal policy. It binds the government to reduce public debt to a sustainable
level, reduce the countrys debt burden every year, mobilize resources at least to the

extent of its current expenditure, prevent the government to cut social sector and
poverty-related expenditures and double education and health budgets. It also forces
the government not to provide guarantee to the borrowings of the rotten PSEs to
prevent the growth of contingent liabilities.
A high-level debt policy coordination office was established in the ministry of finance.
Besides many other functions, the debt office was made the secretariat to monitor the
performance of the law. Every year, before January 31, the debt office prepares two
reports the fiscal policy statement and debt policy statement and submits them to
parliament under Section 6 and 7 of the Act, respectively. While analyzing the
developments on the fiscal and debt front in a year, the reports also give a compliance
report of the Act. Some 500 copies of each report are submitted to the National
Assembly and Senate Secretariat for distribution to the members.
From 2003-04 to 2006-07, the law performed very well. Public debt declined from 75
percent to 55 percent of the GDP during the period. However, most of the critical
elements of the law have been violated in the last four years. In particular, public debt,
instead of declining, has increased to 60 percent of the GDP and revenue deficit
continues to prevail. None of the members of parliament has ever raised the issue of
violation in the House; hence, no debate has taken place in parliament. Nobody bothers
and nobody cares about the law and hence, Pakistans economy continues to create
pain and misery for the hapless millions.
It binds the government to reduce public debt to a sustainable level, reduce the
countrys debt burden every year, mobilize resources at least to the extent of its current
expenditure, prevent the government to cut social sector and poverty-related
expenditures and double education and health budgets. It also forces the government
not to provide guarantee to the borrowings of the rotten PSEs to prevent the growth of
contingent liabilities.
A high-level debt policy coordination office was established in the ministry of finance.
Besides many other functions, the debt office was made the secretariat to monitor the
performance of the law. Every year, before January 31, the debt office prepares two
reports the fiscal policy statement and debt policy statement and submits them to
parliament under Section 6 and 7 of the Act, respectively. While analyzing the
developments on the fiscal and debt front in a year, the reports also give a compliance
report of the Act. Some 500 copies of each report are submitted to the National
Assembly and Senate Secretariat for distribution to the members.
From 2003-04 to 2006-07, the law performed very well. Public debt declined from 75
percent to 55 percent of the GDP during the period. However, most of the critical
elements of the law have been violated in the last four years. In particular, public debt,
instead of declining, has increased to 60 percent of the GDP and revenue deficit
continues to prevail. None of the members of parliament has ever raised the issue of

violation in the House; hence, no debate has taken place in parliament. Nobody bothers
and nobody cares about the law and hence, Pakistans economy continues to create
pain and misery for the hapless millions.
It binds the government to reduce public debt to a sustainable level, reduce the
countrys debt burden every year, mobilize resources at least to the extent of its current
expenditure, prevent the government to cut social sector and poverty-related
expenditures and double education and health budgets. It also forces the government
not to provide guarantee to the borrowings of the rotten PSEs to prevent the growth of
contingent liabilities.
Pakistans Debt:
Foreign Debt is the major problem of Pakistan's Economy. Economy of Pakistan is in
worst shape with growth rate lowest in the region. Although there are many problems of
Pakistan's economy but foreign debt and debt servicing is an important problem of ailing
economy. It becomes impossible for Pakistan to pay foreign debts servicing or interest
on foreign debts without taking more debts.
On October 2010 State Bank of Pakistan reported that country had to pay $1.669 billion
as debt servicing (interest) during the first quarter of fiscal year 2010-11. Size of the
debt servicing increased by over 49% compared to the debt servicing made during the
same period of last year. The country paid $1.193 billion as debt servicing in the first
quarter of last fiscal.
In 2008 financial crises developed in Pakistan and foreign exchange reserves almost
finished due to high price of oil. At that time country had to borrow loan from IMF. The
IMF agreed for $11.3 billion but attached harsh conditions for reforming the economy.
Now the country's ability to pay off external debt is doubtful as any uncertainty in oil
prices could erode the entire reserves.
Pakistan had to pay a total $5.641 billion as debt serving in the fiscal year 2009-10,
which accounts for almost more than 33% of the entire foreign exchange reserves of
country. The total foreign debt and liabilities of Pakistan has reached $58.512 billion,
while it was just $47 billion a couple of years ago.
Another problem is oil prices for Pakistan. Now there is acute energy crisis in Pakistan
and Pakistan depends upon the oil powered or thermal power station for the generation
of electricity. If oil prices again raise it will cost Pakistan more money and there are
chances that reserves will erode more quickly.
The shortfall in balance of trade was more than $11.4 billion during last year, which kept
pressure on external payments. Despite $8.9 billion remittances sent by the overseas
Pakistanis, the country had to face current account deficit last year. Pakistans long-run
debt-servicing capacity is extremely low, primarily due to low savings and productivity. It
is further observed that with the current state of savings and productivity, Pakistan has
to choose between sacrificing growth and prolonging the unsustainable position of
continuously growing debt burden.
How to pay back debt:
The problem with Pakistan is that although it has internal resources to bridge the
budgetary gap but tax collection system in Pakistan is worst in the world and tax to GDP
ratio in Pakistan is not only lowest in the region but lowest in the world. There is only

one way to get out of this vicious circle of debt and that is to generate enough income
from internal resources to pay off the debt servicing and debts. For this purpose
government has to increase its tax net and especially the wealthy people in Pakistan
are not paying taxes. If government fails to generate income from indigenous resources
then they have to take more loans to pay previous loans.
Problems of Balance of Payment deficit and depleting foreign exchange reserves can
be overcome bybuying foreign exchange from overseas Pakistani workers rather than
accumulating foreign loans on tough terms. Cost of this purchase is far less than the
interest paid on foreign loans and involves no repayment of principal.
Overseas workers remittance in real terms is almost equal to entire exports of Pakistan.
If re-routed from Hawala to Banking Channels, it has the potential to convert the
Balance of Payments to surplus, increase our Forex reserves, avoid taking further
foreign loans and payoff Pakistans foreign debt in real terms through our own sources.
Total cost to the Government at present exchange rate shall amount to 2.25% in the
form of incentives to banks and remitters. This shall be the cost of buying USD from
overseas workers. It still will be far less than interest paid on the IMF loans of around 4
% p.a. repayable in USD. In addition, the obvious advantage is that there is no
repayment of principal amount. Hence, no exchange rate risk involved at the time of
repayment as well. All these payments by government in the form of incentives will
remain in Pakistans economy, (unlike loan installments to IMF, which are outflows from
our economy). The part that will go to overseas Pakistanis will be distributed among
their families in Pakistan, hence will have a positive impact in the form of increase in per
capita income, which will be further circulated in local economy, effecting employment
growth and increase in revenue generation for national exchequer. The remaining
amount paid to banks in the form of commission will go towards meeting the cost of
developing systems, resources, network growth, advertisement, etc. The overall effect
of growth and profitability of the local banks will lead to strengthening of our financial
sector, increase in employment and improvement in revenue generation for national
exchequer. This shall also help in curbing smuggling and under-invoicing, as cost of unofficial outward remittances through Hawala will go up.
Pakistan must improve its saving rate by continuing and even further refining the
ongoing process or tax reforms, downsizing of the public sector and privatization of
public sector enterprises. Pakistan needs to improve its overall productivity in the
economy, especially in the public sector. The privatization process needs to be
accelerated for the sake of minimizing the cost of losses in the public sector and
improving productivity rather than revenue generation. Pakistan also needs to manage
its debt in a better way. There is utmost need for enrichment of the intellectual capacity
in the public sector institutions responsible for debt management. These institutions also
need to be reformed thoroughly and given sufficient autonomy.
Pakistan has to be selective in choosing among the alternative aid and loan packages.
External borrowing has to be target specific and the targets have to be specified in the
light of a social welfare function that assigns due weight to social as well as economic
considerations such as growth enhancement, promotion of equity and social justice and
eradication of poverty. External borrowing must be undertaken within the framework of
economic plans rather than making the planning exercise contingent on the availability
of external resources.

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