The author is a former Acting Governor of the State Bank of Pakistan and a former IMF official. The views expressed here are his own.
Earlier this month, Pakistan secured a staff-level agreement with the IMF in its record 24th round of talks. The accompanying IMF press release was conspicuous by its complete absence of any mention of debt sustainability, an omission that is both surprising and disappointing.
In May this year, the IMF came close to diplomatically declaring Pakistan’s debt unsustainable without inviting creditor flight, warning in its latest staff report that Pakistan’s path to debt sustainability was “narrow” amid “severe,” “exceptional” and “uncomfortably high” risks from rising total financing needs and a lack of external financing.
The debt-to-GDP ratio is projected to decline significantly at the end of FY24 due to fiscal consolidation and negative ex-post real interest rates. Nonetheless, risks to debt sustainability remain significant given very large total financing needs and ongoing external financing challenges, and real interest rates are projected to be a negative driver of debt trends over the next few years.
In fund-speak, this was an SOS call. But just a month and a half later, the IMF and the Pakistani government appear to be walking back this candor and trying to postpone the issue. The consequences of this “pretend extension” gamble will likely be tragic.
It would impose unbearable austerity measures on a population already worn down by the past decade of stagnant per capita income, a historic cost-of-living crisis and deep-rooted political dysfunction. It could spark mass social revolts in the world’s fifth-most populous country, as witnessed in Kenya last month. It would also lead to even bigger losses for creditors when the inevitable payout comes. When the dust settles, the IMF’s already tarnished image in Pakistan is likely to be further in tatters.
Some will disagree with this gloomy prediction – ultimately, debt sustainability is in the eye of the beholder – but some facts are irrefutable.
According to the IMF, over the next five years, Pakistan will owe an average of $19 billion in principal repayments to the world annually, more than half of its export earnings, and will need at least $6 billion annually to finance a projected small current account deficit, bringing its total external financing requirements to at least $25 billion per year between now and 2029. Pakistan’s foreign exchange reserves are less than $9.5 billion.
And that’s not all: for the next five years, the government will have to pay an average of 6.5% of GDP annually in interest on debt already owed to residents and foreigners. Pakistan’s total tax revenue is just 10% of GDP.
Understand these facts. If not curbed, this will collapse. And it is difficult for Pakistan to get out of this predicament without debt relief.
First, Pakistan cannot meet its external financing needs without increasing its government debt because it attracts little substantial FDI (less than $2 billion annually) and its private sector is unable to generate foreign capital inflows.
Take the latest IMF loan for example: the $7 billion it is lending is less than Pakistan will have to repay to the IMF over the next four years. This is a classic example of evergreening and a worrying sign of a pyramid scheme at work.
At 77% of GDP, Pakistan’s public debt is already above what is considered excessive for an emerging market, and any further debt buildup would be dangerous. And at 24% of GDP, the country’s total financing needs (the budget deficit plus debt maturing in the next 12 months) are the second largest among emerging markets after Egypt.
As a result, it will be very difficult to borrow abroad at a reasonable cost, and excessive debt will continue to weigh on domestic investment and economic growth.
In fact, things have already come to a head. Consider this disturbing chart from UNCTAD’s Global Debt Dashboard, with Pakistan in the blue dot and the rest of the developing world in orange.
At 6%, the Pakistani government pays higher interest as a percentage of its economy than any other developing country.
Additionally, the ratio of interest payments to government revenue is 65 percent, the second highest in the world after Sri Lanka.
As a result of this heavy interest burden, governments have no financial resources to cover social security costs, which have fallen to some of the lowest levels in the world.
This is terrible because social spending is essential to improving the skills of our people and boosting the quality of jobs, exports and foreign investment in our economy.
In fact, the Pakistani government spends almost three times as much on interest as it does on education, the second worst ratio among developing countries after Sri Lanka.
Similarly, spending on interest is almost six times higher than on health, behind only Yemen, Angola and Egypt. It is no wonder that 40 percent of children under five are stunted and 26 million are out of school.
Huge debt repayment obligations are also squeezing other spending that is crucial to the country’s future: the government is spending twice as much on interest as it invests, the third highest after Angola and Lebanon.
As a result, Pakistan is investing just 12 percent of its GDP, less than 2.5 times what is generally considered necessary for sustained growth.
Worryingly, these problems will continue. Even if Pakistan’s revenues miraculously grow by 3% of GDP over the next three years (as envisaged in the upcoming IMF programme), interest will still consume about half of government revenues. All of this tells us that Pakistan’s debt is unsustainable.
Another way to understand this is to scrutinize the IMF’s own Debt Sustainability Analysis (DSA), which unfortunately comes to the same conclusion.
According to the latest IMFDSA, carried out in January, the government needs to start achieving a primary balance surplus. this year And to ensure Pakistan’s debt is sustainable, it will need to maintain it for years to come: The last time Pakistan ran a surplus was two decades ago during the war on terror, when foreign subsidies were flowing in.
Essentially, the IMF is saying that for Pakistan’s debt to become sustainable, all major past macroeconomic trends would need to be dramatically reversed in some way: despite a significant tightening of fiscal and monetary policy (green bars), the budget would need to be significantly tightened (dark blue bars), the currency would need to be stabilized (yellow bars), and growth would need to be significantly increased (light blue bars).
Another warning sign is that the IMF’s projections for Pakistan’s public debt and the key variables that affect it (primary deficit, real interest rate (r), growth rate (g), exchange rate) have all historically been far too optimistic, as indicated by a flashing red light on the reality scoreboard. Why should this time be different?
So you should make your own judgement as to what the sustainability of the debt looks like.
Unfortunately, as seen in many cases around the world, the consequences of not telling the truth will be an unrealistic and painful fiscal restructuring, with no real scope for protecting the vulnerable, and ultimately a bigger liquidation, as foreshadowed by the government’s recently passed much-criticized budget.
It is particularly unfortunate that the IMF ignored its own latest international research showing that fiscal consolidation undermines growth and fails to enhance debt sustainability, especially when the global economy is weak and uncertain.
Instead, in a situation as dire as Pakistan’s, the pace of fiscal consolidation must be slowed, combined with debt restructuring. A much smarter approach than the austerity measures being imposed on Pakistan would be to restructure public debt in a way that frees up funds for much-needed development and climate spending.
In a world where some 60 countries are drowning in debt, facing huge development spending needs and enormous risks from climate change, Pakistan is the canary in the coal mine — exactly where debt relief and truth-telling are most needed.
