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PRM Policy Note

Pakistan Resident Mission Series No. 1


April 2007

Pakistan’s Public Debt


A BRIEF OVERVIEW

Emma Xiaoqin Fan


Pakistan Resident Mission
Asian Development Bank
1st Floor OPF Building
Sharah-i-Jamhuriyat, G 5/2
Islamabad. Pakistan
© 2007.

PRM Policy Note Series Review Committee

Chair:
Peter Fedon, Country Director, Pakistan Resident Mission,
Asian Development Bank

Members:
Emma Xiaoqin Fan, Senior Public Resource Management Specialist
Safdar Parvez, Programs Officer
Farzana Noshab, Economic Policy Officer
Waqas ul Hasan, Project Officer, Governance

The PRM Policy Note Series is based on papers or notes prepared by


PRM staff and resource persons. The series is designed to provide
concise nontechnical accounts of policy issues of topical interest.
Though prepared primarily for internal readership within the ADB, the
series may be accessed by interested external readers. Feedback is
welcome via e-mail (adbprm@adb.org). The views expressed here are
those of the authors and do not necessarily reflect the views or policies
of ADB.

PRM welcomes submission of brief papers from both ADB staff and
external contributors which are of policy relevance and of importance to
Pakistan for the PRM Policy Note Series. The papers can be submitted to
Mr. Khurram Imtiaz Butt (kbutt@adb.org).
PRM Policy Note
Pakistan Resident Mission Series No. 1
April 2007

Pakistan Public Debt


A BRIEF OVERVIEW

Emma Xiaoqin Fan

Emma Xiaoqin Fan is a Senior Public Resource Management Specialist in the Pakistan
Resident Mission of the Asian Development Bank. The author thanks Peter L. Fedon
and Safdar Parvez for the comments and suggestions they provided when reviewing an
earlier draft.
Pakistan's Public Debt
A brief overview

1. Introduction
Public debt is an important means of bridging government
financing gaps. Effective and efficient utilization of public debt
can increase economic growth and help a government to
achieve its development and social objectives. However,
public debt is also a doubled-edged sword. Excessive reliance
on public debt and inappropriate public debt management
raise macroeconomic risks, impede economic growth, and
hinder economic development. For example, high public debt
demand can increase the domestic interest rate thereby
crowding out private investment. An escalating external public
debt stock increases the probability of default, raising the
interest risk premium charged by creditors. High interest
payments further enlarge a country's public debt obligations,
accelerate budget outlays, and squeeze capital investment
and social expenditure. In extreme cases, governments can be
forced into defaulting on public debt, which tarnishes a
country's international reputation and makes further borrowing
difficult, whereas monetization of public debt generates high
inflation. Both of these actions are likely to precipitate capital
flight and spark financial crisis.

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This note briefly examines the public debt situation in Pakistan.
The objective is to understand the assistance from multilateral
sources, especially from the Asian Development Bank (ADB),
in a broader context. The note pays particular attention to
external public debt in the country.
2. Public debt some conceptual considerations
Public debt can be examined from the sources, the uses, and
debt management perspectives.
In debt financing, government can borrow from a number of
sources, including the central bank, domestic commercial
banks, domestic non-bank sectors, and external sources.
Government usually utilizes a number of options at the same
time. Public debt raised through different sources has different
macroeconomic implications. Borrowing directly from central
banks is equivalent to printing money. It increases the high
power money which in turn translates into monetary
expansion. This approach is thus highly inflationary and
generally discouraged. Borrowing from domestic commercial
banks is less inflationary, although it may crowd out private
investment. Government borrowing from the non-bank private
sector has no effect on the money supply and hence no
implications for interest rates and inflation from the supply
side. However, the debt held by people can exert an upward
pressure on interest rates from the demand side. Borrowing
from abroad has become a major feature of developing
countries. Foreign borrowing allows a country to invest and
consume beyond the limit of current domestic production, and
can be conducive to economic growth. However, excessive
reliance on foreign borrowing exposes a country to numerous
risks (Hanif 2002).
The use of public debt also has economic implications.
Generally speaking, financing capital and development

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related projects can help a country to build its production
capacity and facilitate economic growth. In particular,
borrowing from external sources enables a country to finance
capital formation not only by mobilizing domestic savings but
also by tapping into foreign capital surplus. Foreign borrowing
can thus lead to more rapid growth. For example, Siddiqui and
Malik (2002) found that foreign borrowing increased resource
availability and contributed to economic growth in South Asia.
However, excessive foreign borrowing and its improper use
generate severe debt service obligations and can constrain
economic policies and growth.
A country's debt management program needs to take into
consideration both the source and use of loans so as to raise
and utilize the debt in ways that benefit a country's long-term
development. Debt management is the process by which the
government aims to acquire and utilize the debt efficiently and
effectively. Debt management strategies not only need to
explore new and cheap sources of finance, but also to
consider the proper use of borrowed funds. The technical
aspects of debt management focus on the need to determine
the level of financing requirements and to ensure that the terms
and conditions placed on borrowers are commensurate with
their future debt servicing capacity. The institutional aspects of
debt management deal with organizational, legislative,
accounting, and monitoring aspects of new borrowing as well
as the total stock of debt. The availability of funds and the
market conditions are important for the choice and design of
borrowing instruments (Hanif 2002).
A key to external debt management is debt sustainability. This
term refers to the level and combination of debt which allows a
country to meet its current and future debt service obligations
in full, without recourse to debt relief and rescheduling, and
avoiding accumulation of arrears. Sustainability of debt is a

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situation where the debt-to-income ratio declines, or at least,
remains constant over years. A general consideration is that for
the debt ratio to remain unchanged, the budget deficit does
not have to be zero, but it must not push the debt to increase
faster than GDP. Thus, the conventional wisdom does not
consider public debt per se as a major problem. Rather, the
core problems are the mismanagement and/or unsustainable
nature of public debt (Hanif 2002).
There are various indicators for determining a sustainable level
of external debt. Broadly, there are two types of debt indicators
that assess the country's debt sustainability position: solvency
and liquidity indicators. The solvency indicators include ratios
such as debt to GDP, debt to foreign exchange earnings, debt
servicing to foreign exchange earnings, and the public debt
service to current fiscal revenue ratio. These measures reflect
the country's ability to service its external obligation on a
continuing basis. The liquidity indicators include ratios such as
reserves to short-term debt and reserves to total debt. They
reflect a country's liquid assets that affect the ability to service
its immediate external liabilities.
3. Public Debt in Pakistan
Pakistan entered the 21st Century with serious financial
problems. Public debt exceeded 90% of its GDP, over 600% of
its annual revenues, and debt servicing accounted for over half
of current revenues. In 2001, Pakistan was the only country in
South Asia to be classified as a severely indebted country by
the World Bank. Due to the inability to service external debt,
there were two consecutive rounds of debt rescheduling by
Paris Club members and one from the quasi-London Club
between 1998 and 2001. Pakistan had to seek exceptional
financing arrangements from the International Monetary Fund
in January 1999, after facing a severe balance of payments'
crisis. This outcome was the result of persistent and rising

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fiscal deficits, stagnant export receipts, declining worker
remittances, and large current account deficits.
The Pakistan economy has experienced a turnaround since
2000. Growth has accelerated, and most macroeconomic
indicators have improved. Public debt indicators have also
shown significant improvement. Modest growth in public debt,
coupled with the strong growth in nominal GDP, led to a
significant fall in public debt to GDP ratio, from 81.4% in
2001/02 to 56.1% in FY 2006 (Table 1). Over the same period,
domestic public debt to GDP ratio fell from 40.4% to 29.9%,
while the external public debt to GDP ratio fell from 41.0% to
26.2%. In fact, FY2005/06 is the fifth successive year that the
public debt to GDP ratio has improved. This is also the first time
in more than two decades that the ratio has fallen below 60%.
The Fiscal Responsibility and Debt Limitation Act, 2005
envisaged a debt to GDP ratio of 60% by FY13. The actual
achievement has thus exceeded the target in the Act (IMF
2006).
The improvement in the public debt to GDP ratio in FY06 was
due to the fact that both domestic and external debt grew
slower than GDP. The growth in domestic debt has been
slightly faster than that of external debt. It rose by about 5.9%
while external public debt grew by about 5.0% relative to the
previous year. Total public debt stock stood at around $72
billion, about 5.5%, higher than the previous year, of which
domestic public debt consists of about $38 billion. As a result
of a stronger rise in domestic debt, the share of external public
debt in total public debt decreased from 50.4% in FY2002/03 to
46.7% in 2005/06.
The debt servicing capacity of Pakistan has also improved over
the past few years. As growth in foreign exchange earnings in
Pakistan outpaced the growth in debt servicing payments,
external public debt servicing as a share of exports of goods

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and non-factor services declined from 35.8% in 2001/02 to
14.1% in 2005/06. The external debt service to gross reserves
ratio has declined from about 70% in 2001/02 to over 20% in
2005/06. International reserves act as a cushion against
fluctuations in foreign exchange earnings.
Pakistan's external debt is predominately long and medium
term debt. Over 99% of public and publicly guaranteed debt is
over one year. Pakistan acquired about US$ 3.3 billion long-
term loans in FY 2005/06, of which about US$ 1.7 billion
reflects the long-term flows from ADB and the World Bank.
While approximately US$ 1.7 billion in loans were committed
by international donors for the earthquake fund in 2006, the
actual disbursement was limited to US$ 768 million, of which
US$673 million of the disbursement came from the ADB and
World Bank. The remaining multilateral loans disbursed in
FY06 were mainly to support poverty reduction and economic
reforms.
The ADB disbursements in FY06 included US$60 million and
US70 million for social services programs to the Punjab and
Sindh Governments respectively to improve the quality of
human capital, specifically in education and health. Another
ADB loan of US$80 million was disbursed under the financial
markets and governance program. Punjab received US$ 199
million from the World Bank for education sector reform. The
World Bank also disbursed a loan of US$ 102 million for Punjab
irrigation/policy-II and US$ 69.5 million for NWFP (SBP 2005).
Clearly, the loans from the ADB and the World Bank play an
important role in the government's external debt financing. The
relatively high share of the multilateral loans calls for sound
program/project design and implementation in order to yield
the maximum benefits to the country. Indeed, the multilateral
development banks are the largest creditors for Pakistan's
external public debt, totaling about 51% of total public external

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debt in FY2005/06. This is followed by the Paris club which
accounts for about 39%. In recent years, the outstanding stock
of Paris club debt declined, partly due to debt write off. Debt
from other sources has been relatively small. Despite this,
activities from bi-lateral agencies have also increased.
Pakistan also accessed the international capital market to raise
funds through the issuance of Euro Bonds in FY 2006. This
raised US$ 800 million which consists of 10-year bonds of US$
500 million and US$ 300 million in 30-year bonds. The
issuance of the Euro bond not only addresses the
government's finance needs, but also helps to establish a
long-term sovereign benchmark that would help local
corporate enterprises access global markets.
4. Factors underlining the improved debt indicators
in Pakistan and issues
The improvement in the debt indicators reflect acceleration in
economic growth, improvement in fiscal conditions, increases
in export earnings, and higher capital inflows. In particular,
external conditions have become more favorable to Pakistan
since September 2001. This has enabled relief of public debt
amounting to about $3.7 billion between 2001 and 2003.
Coupled with debt rescheduling, this has significantly reduced
Pakistan's debt servicing burden. There have been increased
official transfers, especially between 2001 and 2004. Total
official transfers amounted to about $4.5 billion from 2001 to
2006. Workers' remittances have also increased significantly,
averaging around $4 billion a year during 2003-2006
compared to about $1.5 billion in the 1990s. These factors
have reduced the need for external borrowing.
There has been a particularly noticeable increase in foreign
direct investment (FDI) in Pakistan in recent years, reflecting
the country's privatization programs and increased investor

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confidence. FDI rose from $483 million in FY2002 to $3.5 billion
in FY2006. The first half of FY2007 saw a further 64.6% increase
to $1.9 billion. The sale of the Karachi Electric Supply Company
and the partial sale and transfer of management control of
Pakistan Telecommunication Company Limited revitalized the
privatization process in 2006. FDI inflows, excluding
privatization, also rose by 70% in 2006. Strong foreign demand
for Pakistani assets (including from oil-exporting countries in
the Gulf region) was also reflected in the favorable terms for
new bond placements in international capital markets. The FDI
and other capital inflow have more than offset the current
account deficit, and resulted in payments surplus of over US$1
billion in 2006.
While Pakistan has significantly improved its economic
performance and the debt situation, strong efforts must be
made to guard against potential risks. First, the improved debt
indicators in Pakistan are closely linked with favorable external
conditions. To sustain sound economic performance over the
long term, Pakistan must maintain political and economic
stability. Economic reforms must go on apace to sustain and
improve domestic and foreign investors' confidence. A sound
policy environment that attracts sustained FDI inflow is
particularly important given that FDI involves long term
financing and is not susceptible to sudden withdrawals.
Creating a conducive policy environment for increased
domestic investment is also a key.
Second, coupled with strong capital inflow, the current account
deficit has increased since 2005. In FY2006, the current
account deficit, excluding official transfers, more than tripled to
$5.7 billion, or 4.4% of GDP as import growth outstripped
export growth because of higher oil prices and strong
domestic demand. Privatization proceeds, official grants, and
portfolio investment together financed 45.3% of the current

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account deficit. The rising current account deficit per se is not
necessarily a problem. For example, strong domestic capital
formation can lead to increased demand for capital goods
financed by capital inflow. Singapore had run current account
deficit for more than 10 years during its rapid industrialization
period. To a certain degree, a current account deficit and
balance of payments surplus indicate the strengths of the
domestic economy and the confidence of foreign investors in
the domestic economy. However, increased current account
deficits raise concerns about the sustainability of financing
large deficits in the medium and long term if the capital inflow is
not significantly contributing to the increased productive
capacity and efficiency of a country.
Third, the large inflow of official assistance and workers'
remittance also poses the risks of Dutch Disease in that high
capital inflow can lead to real exchange appreciation,
rendering domestic tradable sectors, especially the
manufacturing sectors, less competitive. The utilization of
foreign aid thus must be geared towards spending on
increased productivity and to provide a conducive
environment for private sector development while avoiding the
fostering of a bloated public sector.
5. Conclusions
This note briefly reviewed public debt information for Pakistan.
It reveals a number of important features.
First, the public debt situation is closely related to broader
economic performance. Accelerating economic growth,
improving fiscal conditions, increasing export earnings, and
increased foreign direct investment have provided the
foundation for improved debt management in Pakistan.
Second, the improved debt situation is also attributable to
more favorable external conditions for Pakistan since

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September 2001. This has led to debt relief and rescheduling,
and increased official inflow and workers remittances. While it
has helped the country to achieve a significant improvement in
debt indictors in the short run, it also exposes Pakistan to risks
relating to the sustainability of both economic performance
and debt management.
Third, in order to sustain and build on its existing
achievements, Pakistan needs to deepen its structural reforms
to improve the domestic investment environment, external
competitiveness, sustain macroeconomic stability, and
maintain political stability. Reforms that improve a country's
creditworthiness and investment climate are important for
improving domestic savings and investment, attracting FDI,
and diversifying the financing sources. FDI is especially
important because it not only brings in finance, but also
contributes to technology transfer and improved management
know-how. Pakistan has had considerable success in
attracting FDI in FY06. However, much can be done to improve
on this performance in the years ahead.
Fourth, sound public debt management supports
macroeconomic stability and economic growth. Debt
management should take advantage of favorable economic
conditions to strengthen the technical and institutional
capacity in managing public debt.
Fifth, multilateral development banks play an important role in
lending to the Government. This calls for sound project and
program designs and implementation to enhance the
effectiveness of development assistance. Introducing
innovative and efficient assistance approaches and practices
in response to the changing context of economic development
is especially important.
The recent economic development and developments in

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external debt show that Pakistan is at a cross road. The strong
economic performance, including the improvement of the
public debt situation over the past few years, if sustained, can
put Pakistan on a sustained growth path. But there are real
challenges and risks that need to be managed carefully.
Maintaining political stability, sound macroeconomic
management, and structural reforms are key for Pakistan to
move forward.

Table 1. Public debt indicators in Pakistan


FY FY FY FY FY
2001/02 2002/03 2003/04 2004/05 2005/06 (est)
1. Debt stocks (US$ million)
Total Government debt 58526.60 62197.80 66511.80 68598.00 72369.00
Public debt: domestic
29047.60 32461.80 35021.70 36408.00 38571.00

Public debt: External 29479.00 29736.00 31490.10 32190.00 33798.00

2. Debt as a % of GDP (%)

Total government debt 81.40 75.30 67.80 61.80 56.10


Domestic public debt 40.40 39.30 35.70 32.80 29.90
External public debt 41.00 36.00 32.10 29.00 26.20
3. Annual average growth
rate of debt (%)
Growth: total public debt 6.27 6.94 3.14 5.50
Growth: domestic public debt 11.75 7.89 3.96 5.94
Growth: external public debt 0.87 5.90 2.22 5.00
4. External public debt as % of 50.37 47.81 47.35 46.93 46.70
total public debt

5. External debt service (%)

external public debt service


as % of exports of goods 35.80 26.60 17.30 16.10 14.10
and nonfactor services
external public debt as % of
exports of goods and 282.00 229.00 209.50 183.70 168.30
nonfactor services

external public and publicly 679.71 312.06 298.09 328.30 314.11


guaranteeddebt as % of
gross reserves

Source: International Monetary Fund, Pakistan: 2006 Article IV Consultation Staff Report

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Table 2. External Debt Stock ($ million)
** **
ITEM 30/06/02 30/06/03 30/06/04 30/06/05 30/06/06 30/09/06

1.Public and Publically-Guaranteed debt 29235 29232 29875 31084 32603 33153
A. Medium and long term(>1 year) 29052 29045 29853 30813 32407 32897

Paris club 12516 12607 13558 13014 12831 12818

Multilateral 14331 14950 14349 15358 16527 16989


Other bilateral 429 512 720 805 847 929
Euro bonds/Saindak Bonds 643 482 824 1266 1908 1906
Military debt 819 263 204 188 130 90

Commercial Loans/credits 314 231 198 182 165 165

B Short Term(<1year) 183 187 22 271 196 256


IDB 183 187 22 271 196 256
2.Private Non-guaranteed Debts
(M&LT:>1 yr) 2226 2028 1670 1342 1585 1565

3.IMF 1939 2092 1762 1611 1491 1478

Total External Debt (1 through 3) 33400 33352 33307 34037 35679 36196

4.Foreign Exchange Liabilities* 3132 2122 1951 1797 1586 1528


Foreign Currency Accounts 406 0 0 0 0 0
** **
30/06/02 30/06/03 30/06/04 30/06/05 30/06/06 30/09/06
FE - 45 234 0 0 0 0 0
FE-13/For 01:FE25CRR w/SBP 0 0 0 0 0 0
FE - 31 deposits (incremental) 172 0 0 0 0 0
Special U.S $ Bonds 924 696 552 421 247 211
Foreign Currency Bonds (NHA/NC) 197 175 153 131 109 87
National Debt Retirement Program 75 6 1 0 0 0
Central Bank Deposits 750 700 700 700 700 700
NBP/BOC Deposits 500 500 500 500 500 500
Other Liabilities (SWAP) 280 45 45 45 30 30

FEBCs/FCBCs/DBCs* 66 42 22 10 7 6

Total External Liabilities (1 through 4)* 36532 35474 35258 35834 37265 37724
Official Liquid Reserves 4337 9529 10564 9805 10765 10,187
* Excluding FEBCs/FCBCs & DBCs from 30/06/99
_ 1/ Resheduled Private Debt included by GOP so excluded from the stock of Private debt
**Provisional
Source: State Bank of Pakistan, http:/www.sbp.org.pk/

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References

Hanif, Muhammad Nadeem, The Journal, National Institution


of Public Administration, Karachi, Pakistan Vol. 7, No. 4, Public
Debt Management, pp. 41-72, Dec. 2002.

International Monetary Fund (IMF), Pakistan: 2006 Article IV


Consultation-Staff Report: Public Information Notice on the
Executive Board Discussion; and Statement by the Executive
Director for Pakistan, Washington DC, 2006.

Siddiqui, Rehana and Malik A. Debt and economic growth in


South Asia, Paper presented in the 17th Annual General
Meeting of PSED, Islamabad, January 2002.

State Bank of Pakistan (SBP), Annual Report 2005-06.

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About the Asian Development Bank

ADB is dedicated to reducing poverty in the Asia and Pacific region


through pro-poor sustainable economic growth, social development,
and good governance. Established in 1966, it is owned by 67
members - 48 from the region. With headquarters in Manila, ADB has
26 offices around the world and more than 2,000 staff from over 50
countries. In 2006, it approved loans and grants for projects totaling
US$8.5 billion, and technical assistance amounting to almost
US$242 million.

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