8 Domestic and External Debt

8.1 Overview

Despite a small increase in the overall debt stock during FY03, Pakistan's debt profile witnessed a significant improvement for the second successive year, with a sharp reduction in the cost of debt, a lengthening of the maturity profile, reduced dependence on external debt, as well as a sharp fall in the debt to GDP ratio.

In fact, the growth in Pakistan's overall debt stock has slowed significantly in recent years, driven primarily by the government's improved fiscal position, pre-payments of expensive debt and the strengthening of domestic currency. This was also evident in FY03, which saw the stock of public debt rise by only 1.0 percent (Rs 38.6 billion) by end-June 2003, pushing down the debt to GDP ratio from 104.3 percent in FY02 to 95.1 percent in FY03.

Table 8.1: Changing Profile of Pakistan's Total Debt

Moreover, the rise in the debt stock emanates entirely from a sharp 7.8 percent increase in domestic debt, as the rupee value of the country's external debt and explicit liabilities declined for the second successive year. In turn, all of the increase in domestic debt during FY03 stemmed entirely from long & medium-term debt (see Table 8.1). The latter, in particular, is certainly very commendable, given that domestic interest rates were at historical lows, however, the large share of relatively expensive borrowings through the NSS is a little disappointing.

 

Also, given that the higher long & medium-term borrowings were, in part, substituting for a decline in the government T-bill stock, the share of short-term debt in the overall domestic debt dropped sharply. Furthermore, the ownership of the domestic debt also shifted, due to higher reliance on non-bank borrowings.

 

In terms of external debt, the most noteworthy development was the reduction of Rs 77.9 billion in external debt stock during FY03 (see Figure 8.1). However, it is pertinent to note that the FY03 reduction stems primarily from: (1) the write-off of bilateral debt totaling approximately US$ 1.0 billion by the US; (2) retirement of commercial loans; (3) repayment of first installment of Euro bonds; and (4) pre-payment of a portion of private commercial debt. Therefore, the quality of debt reduction in FY03 is significantly better than FY02 (which was only due to the appreciation of rupee by 6.7 percent that offset a US$ 1.2 billion rise in the debt stock during the period).

 

The impact of the reduction in the stock of external debt was reinforced by: (1) the replacement of expensive external debt with cheaper borrowings, mainly due to substitution of non-concessional loans with soft loans from IFIs; and (2) re-profiling of bilateral (Paris Club) loans, that reduced its net present value by 32 percent. Also, the repayments of maturing 3-year Special US Dollar Bonds substantially reduced the stock of explicit liabilities by Rs 17.9 billion during FY03.

 

The above improvements, along with rising foreign exchange earnings (exports and remittances) during FY03, also enhanced the country's capacity of servicing external debt & liabilities. This improvement together with, the aggregate decline in the share of external debt and liabilities in Pakistan's overall debt profile makes its clear that the vulnerability of the economy to external shocks has reduced significantly during the year (see Figure 8.1). This trend is expected to gather further momentum with the likely pre-payment of private loans as well as the planned pre­mature retirement of expensive IFIs loans during FY04.

 

Not surprisingly, the substitution of  expensive external debt with soft term debt, the re-profiling of bilateral debt from Paris Club and falling interest rates on domestic debt led to a notable improvement in all debt servicing ratios in FY03 (see Figure 8.2). Despite the considerable improvement over the last few years, it is however, important to remember that the debt burden on Pakistan's economy is still significant.1 It will require much effort and discipline over a number of years before the country returns to a sustainable debt path.

 

 

8.2 Domestic Debt

 

After an unusual dip in FY02,2 public domestic debt resumed its traditional upward trend in FY03, rising by 7.8 percent to reach Rs 1852.4 billion at end-June 2003.3 However, the FY03 growth rate is significantly lower than the double-digit average growth rate for the past five years (both excluding and including FY02).4 This slowdown in the growth rate is attributable, inter alia, to: (1) greater fiscal discipline by the government and PSEs (which reduced funding requirements), as well as, (2) the increased availability of external financing (lowering the domestic financing requirements).

 

The other extremely significant gain during FY03 was the sharp plunge in the domestic debt servicing cost amidst a general decline in interest rates (see Section 5.1.1). This is most visible in short-term debt given that: (1) the decline in short-term interest rates was much greater; and that (2) the entire stock of the short-term debt was rolled-over as it matured during the year (since only a portion of

long-term debt was retried during FY03, the overall impact of lower interest rates on its stock was correspondingly smaller).

 

Table 8.2: Profile of Domestic and External Debt

 

 

 

 

The term structure of the domestic debt also underwent a substantial change, with long-term debt constituting an increasing proportion of the public debt issued during FY03. In fact, the entire addition to the debt stock in FY03 stems from a rise in the long-term debt, which more than offset the reduction in short-term debt during the year. There are two important issues relating to this unusual shift in the borrowing pattern:

 

1)            Given that long-term rates were currently at their lowest levels in past few decades, this could have extremely positive implications for the government's long-term debt servicing profile, if the fresh borrowings are used to retire the more expensive long-term debt, or for (long-term) project financing;

2)     More importantly, however, there is a concern that a significant part of the abnormal jump in receipts under the NSS is only temporary. There is strong evidence that a significant component