akistan today finds itself at a critical juncture, facing the daunting challenge of an escalating external debt crisis that threatens its economic stability. The statistics paint a grim picture: the external debt stands at a staggering 36.4 percent of the GDP ($131 billion as of December 2023) surpassing regional countries like India (18.9 percent) and Bangladesh (13.73 percent). The urgency of finding a solution cannot be overstated. What follows is an analysis of the borrowing patterns across governments and their ramifications for the nation’s economic future.

Pakistan’s demography and economic standing do not match. Ranked fifth globally in terms of population size, the country is a modest 46th in terms of economic activity. USA, China and India, the three most populated countries, have the three largest economies. Even Indonesia, the fourth largest in terms of population has the 16th largest economy. This incongruity underscores systemic challenges in economic governance and fiscal management that have plagued the nation for decades, manifesting most prominently in its burgeoning external debt.

Borrowing: historical perspective

Since its inception, Pakistan has heavily relied on foreign loans. In recent years, the country’s debt burden has escalated rapidly, with the debt-to-GDP ratio soaring to an alarming 90 percent, surpassing the 60 percent ceiling set by the Fiscal Risk and Debt Limitation Act, 2005. This situation calls for inquiries into the sustainability of Pakistan’s debt burden and its ramifications for economic growth and development.

Pakistan’s debt servicing has risen from 35 percent to 58 percent of total revenues. The total debt and liabilities rose from 65 percent to 90 percent between 2008 and 2022. The escalation significantly impacted Pakistan’s development spending, which declined from 20 percent to 12 percent over the same period. This directly affected government expenditure on sustainable development goals and key sectors like health and education.

The pattern of borrowing to fuel development has been consistent across governments.

The management of foreign debt holds paramount importance for developing countries as it is the primary source of budgetary support to manage deficits and fund crucial sectors. Given Pakistan’s ongoing economic challenges, it is imperative for the administration to meticulously analyse the links between various development indicators and the accumulated foreign debt. Such scrutiny is essential for devising effective strategies to navigate the country’s economic crises and ensure sustainable development.

Research on the relationship between external debt and economic growth has exploded after the debt crisis that hit many developing countries in the 1980s. Many empirical studies on the relationship between economic growth and external debt found the results ambiguous. The existing literature can be divided into three groups. The first group suggests that because the poor countries are far away from steady state, any injection in the form of foreign debt could lead them to accelerated economic growth. Therefore, foreign debt has a positive impact on growth until a certain threshold is reached. The second group suggests that high accumulated debt stock has a negative impact on growth. A leading explanation for this negative relationship is the so-called debt overhang hypothesis of Krugman (1988), and Sach (1989), then advocated by Cohen (1993). The third group combines these two effects and argues that the impact on growth is non-linear. Krugman (1988) defined the overhang effect as a situation in which the expected repayment on foreign debt falls short of the contractual value of the debt.

Borrowing without bounds

From the PPP to the PML-N and the PTI, emphasis was on long-term infrastructure funding. Each administration significantly contributed to the surge in external debt.

The PPP administration borrowed $25 billion while retiring $14 billion loans between 2008 and 2013. The PML-N $49.8 billion and retired $27.1 billion loans between 2013 and 2018. The PTI government borrowed $52 billion and repaid $36.05 billion from 2018 to 2022.

During the PPP tenure (2008-2013), the foreign debt financing policies aimed to tackle pressing economic challenges, including a balance of payments crisis and energy shortages. The PPP adopted a mixed approach, borrowing from international financial institutions, such as the IMF and the World Bank, as well as friendly countries like China and Saudi Arabia. The $7.6 billion loan obtained from the IMF in November 2008 addressed the balance of payments crisis. The government also secured substantial loans and grants from China for infrastructure projects, such as the construction of the Gwadar port and the renovation of the Karakoram Highway.

In terms of debt management, the PPP introduced some measures to enhance efficiency. These included cutting energy subsidies and increasing interest rates to tighten the monetary policy. While engaging with international financial institutions to address external debt challenges, the PPP implemented fiscal and monetary reforms, including tax reforms and improvements in the energy sector. However, their overreliance on external borrowing and inadequate focus on boosting exports and domestic revenue generation drew much criticism. The party’s borrowing strategy led to a significant increase in Pakistan’s external debt burden, which rose from $44.7 billion in 2008 to $60.9 billion in 2013.

During the PML-N tenure (2013-2018), the focus was on securing long-term loans from international financial institutions and friendly countries to fund infrastructure development projects.

The party secured a $6.6 billion loan from the IMF in September 2013 (to stabilise the economy and boost growth while expanding its social safety net to protect the poor.), followed by a $1.5 billion loan from the ADB in November 2013. The party also secured significant loans and grants from China, including the China-Pakistan Economic Corridor project.

In terms of debt management policies, the PML-N implemented measures to improve the efficiency of the debt management system. It also engaged with international financial institutions to address Pakistan’s external debt challenges. The government participated in an IMF Extended Fund Facility programme that aimed to stabilise the economy and address the external debt burden. The PML-N’s foreign debt financing policies were criticised for overreliance on external borrowing and insufficient focus on increasing exports and domestic revenue generation. The government’s strategy led to an increase in Pakistan’s external debt burden from $60.9 billion in 2013 to $95.2 billion in 2018.

Coming into power in August 2018, the PTI government criticised the previous governments’ reliance on external borrowing and committed to reduce Pakistan’s external debt burden. In terms of borrowing strategy, it focused on short-term loans and grants from friendly countries and international financial institutions.

The party secured a $6 billion loan from the International Monetary Fund in July 2019, followed by $1.8 billion (to address the root causes of its chronic fiscal crisis, diversify trade avenues, enhance competitiveness and reform its energy sector) from the Asian Development Bank in September 2019. The party also secured loans and grants from friendly countries like China, Saudi Arabia and the UAE.

In terms of debt management policies, the PTI government renegotiated Pakistan’s foreign debt agreements to make them more favourable. It also renegotiated several agreements with Saudi Arabia (e.g. $3 billion in foreign currency support for a year to address its balance-of-payments crisis). The government secured favourable terms for the loan, including a reduction in the interest rate and a deferral of payments for three years; a one-year deferred payment facility for import of oil, up to $3 billion). In 2019, Pakistan and Qatar signed an agreement to reduce the price of LNG imports from Qatar. It was later renegotiated in 2020 to further reduce the price.

The government secured deferred payment agreements on oil imports, which helped reduce the country’s import bill. The renegotiation of these foreign debt agreements helped ease the debt crisis. However, there were concerns that the renegotiation may have long-term implications, such as increasing Pakistan’s dependence on certain countries for financial assistance.

The PTI also introduced measures to improve the transparency and efficiency of the debt management system. It sought to engage with international financial institutions to address Pakistan’s external debt challenges. The government participated in the Debt Service Suspension Initiative launched by the G20 countries in response to the Covid-19 pandemic, which aimed to provide debt relief to developing countries. The PTI also initiated discussions with the IMF and other creditors to restructure and reschedule Pakistan’s external debt. The borrowing strategy led to an increase in Pakistan’s external debt burden, which grew from $95.2 billion in 2018-19 to $130.3 billion in June 2022-23.

Debt management: capacity and productivity

The issue of a government’s capacity for effective debt management raised critical questions about feasibility, productivity and overall transparency of borrowing. Pakistan’s international ratings in assessments, such as the Public Expenditure and Financial Accountability highlight significant shortcomings. These include a mere C+ for debt management, a D for arrears management, and a C+ for debt predictability overview. Moreover, Pakistan’s Open Budget Index rating of 46 out of 100 for transparency in debt management, coupled with a dismal 9 out of 100 for public participation, underscores the urgent need for improvement.

A striking discrepancy of over 20 percent between actual and budgeted debt figures underscores another challenge. The Medium-Term Debt Strategy reports and debt bulletins focus primarily on loan repayment timeliness and budget deficit financing, neglecting critical assessments of loan productivity.

The current focus on securing foreign loans to address the current account deficit has led to a lack of scrutiny with regard to productivity and feasibility.

Many foreign loans secured on behalf of the provinces have lacked thorough research and feasibility studies.

A call to action

Foreign debt’s impact on macroeconomic indicators is multifaceted. Developing nations resort to foreign borrowing when their expenses surpass revenue. The loans are used to cover fiscal deficits and fund development projects. These loans directly and indirectly affect indicators such as trade, inflation, exchange rates, consumption, investment, GDP growth and debt servicing.

As Pakistan stands on the brink of economic turmoil, decisive action is imperative. From diversifying funding sources to fostering sustainable growth and strengthening debt management capacity, a multifaceted approach is needed. Since 2008 a significant portion of the external loans has helped finance debt-servicing. Moreover, factors like currency depreciation, inflation, political instability and inconsistent economic policies have led to capital flight, hindering GDP growth and necessitating further debt accumulation to maintain foreign reserves.

To address these issues, the government must devise a comprehensive long-term debt management strategy, prioritising reduced reliance on foreign borrowing. Such a strategy should focus on repaying existing debts, averting new debt accumulation and diversifying funding sources. By lowering borrowing costs, enhancing debt sustainability, fostering investor confidence, promoting transparency and supporting economic growth, such a strategy can mitigate risks associated with foreign debt.

Diversification of funding sources beyond traditional lenders like the IMF and World Bank is crucial. Attracting foreign investment, issuing bonds in international markets and exploring alternative financing avenues can reduce dependency on specific creditors or debt instruments, thereby mitigating repayment risks.

Examples from countries like China, India and South Africa underscore the benefits of diversifying funding sources. China’s issuance of debt in various currencies has reduced exposure to currency fluctuations and broadened investor markets. India’s issuance of bonds in various currencies has lowered borrowing costs and reduced reliance on domestic investors. South Africa’s issuance of sukuk bonds has tapped into new funding sources while complying with Islamic financial principles to diversify its investor base.

Pakistan faces a formidable challenge in its escalating external debt crisis. Urgent reforms are needed to address systemic issues in debt management and chart a path towards economic resilience and prosperity. Failure to do so risks condemning future generations to bear the burden of unsustainable debt, underscoring the gravity of the situation and the imperative for decisive action.

Effective management of Pakistan’s foreign debt necessitates a multifaceted approach. By prioritising sustainable economic growth through structural reforms, attracting foreign investment and promoting export-oriented industries, the nation can enhance its resilience to debt burdens. Refining debt sustainability analysis, bolstering debt management capacity through investments in staff training and technology and enhancing transparency in debt management practices are crucial steps towards prudent debt management. Pakistan’s path to prosperity lies in raising productivity, lowering energy costs, investing in agriculture and implementing significant reforms in public finance.

The writer is a public financial management expert. He can be reached at waqas_paracha@hotmail.com