Understanding Pakistan’s $210bn debt situation with former Finance Minister Dr Salman Shah

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Pakistan currently has $210bn in total debt which is close to 70 percent of its gross domestic product; external debt of over $85bn, and a further $125bn of domestic debt. Total debt jumped from $140bn in 2013, which was 60 percent of GDP, the statutory limit ceiling on debt.

Pakistan has not only added $70bn in the last four years but is now faced with a weakening dollar-rupee exchange rate, thus making foreign debt even more expensive for the country. GVS sat down with the former Finance Minister, Dr Salman Shah to understand Pakistan’s debt situation and related issues.

GVS: Should we be worried about the level of debt Pakistan is burdened with?

SS: Well I think, number one, for a developing country to take on some debt for its development and running the government is not an unusual thing but the real issue is, how much and what kind of debt one takes on that is important. What are the kinds of pressures that are contributing to the accumulation of this debt?

In our particular case, we have domestic debt and we have international debt. Then we have what has become very popular or infamous in Pakistan, which is circular debt. Followed by this are things like quasi-debt that are not called debt but are similar to debt. Quasi-debt is what we have in the power sector where we have companies that produce power under an agreement and are independent power producers.

The money that has to be paid to them through the tariff is guaranteed by the government of Pakistan – so behaves just like debt – and is thus a foreign exchange liability for the country, because most of the money given to them is in foreign exchange.

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GVS: Foreign debt is around $85 billion but the overall debt to GDP is 67 percent. This is not a tremendously high number as compared to some other countries in the world.  Why are people concerned?

SS: Number one, this violates our law. There is a debt limitation act called Fiscal Responsibility and Debt Limitation Act, which was passed in 2005. The law says that overall debt should not exceed 60%. The debt was coming down very rapidly, in fact, it had come down to about 54% of the GDP. From there it has gone back up again to 67% and I have seen numbers which suggest that it may be higher. Now, this breaks the law.

The second is that we have to see how sustainable the debt is. When we talk about sustainability of debt, primarily it is foreign debt that becomes important. As you know, the foreign debt is being driven by a very large current account deficit because the trade deficit is ballooning. We import a lot more than what we export and as a result, we have to finance that through debt. There are other ways for financing also, through investments and remittances.

But, investments are not coming in and while remittances do finance the trade deficits to an extent, however, the trade deficit is still very large. That becomes a problem because if you can’t raise more than to repay the old debt then you end up losing your foreign exchange reserves which is a very destabilizing situation and the rupee will lose its value very sharply.

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GVS: IMF and other organizations have said that the rupee is overvalued by almost 24%. Given the fact that you mentioned that we have a trade account deficit as well, do you think we need to devalue?

SS: The value of the currency is, of course, the purview of the State Bank of Pakistan. They can decide whether it is undervalued or overvalued. They may like to withdraw whatever support they are providing it to keep it at a certain level. However, Pakistan’s rupee value is to some extent market flows.

Occasionally, the Central Bank intervenes to prop it up. If they don’t prop it up, it will start to go down and if there is a very large deficit that cannot be financed then that value falls very sharply. When it falls, then number one it hurts your fiscal balance because the fiscal deficit will go up because of higher debt servicing costs so you are in a debt spiral as well.

Secondly, the money that you are spending on lots of these projects like CPEC etc. would go up substantially. The cost of CPEC would increase rapidly. So, a $50 billion investment in CPEC has a different value for the country at for example at Rs. 80 to a dollar vs. Rs. 160 a dollar in rupee terms.

The cost would then have to be financed through domestic borrowing or through the budget. I think that all those issues become very important. One of the main roles of the Central Bank is to ensure that the value of the rupee is maintained at a reasonable level.

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GVS: What do you consider that to be? Do you have anything in mind?

SS: Of course, the State Bank will take into account the trade deficit and the current account deficit when they’re looking at all this. How this would be financed and in the long run where they see the value of the rupee stabilizes. I would not like to say what would be a good value, but as you said that the IMF thinks that a 20% more devaluation is needed, then that’s not a good number. It depends on the financial flows which are taking place.

On the other hand, I think the export numbers may be bad because of other problems. For example, the textile industry says that their energy bill is too high because they have to pay for the energy and inefficiencies of Pakistan and since the IPP charges a very high rate of return and they’re also very expensive and all the problems of the power sector cannot be thrown at the export sector as they would become non-competitive. So, the exchange rate can affect their competitiveness in the short run, but in the long run, they have to have better productivity and a lower cost of business to be effective.

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GVS: Do you think CPEC related debt is good debt?

 SS: The real issue is what is and is not good debt. The assumptions we make about debts are that the government is very efficient in the utilization of the debt and that is the fly in the ointment. If we look at the power projects we have ended up with energy that is twice the cost compared to other countries in the region, as India, or as compared to Bangladesh, there seem to be lots of padding in these projects.

In other words, if we are spending $2 billion on our projects the real cost is really $1 billion and the other is bad management, incompetence, corruption, etc. So, all these factors come in and make the debt unsustainable.

I think once you decide to take on the debt then you have to ensure that you are putting it into those activities that will generate sufficient economic growth and sufficient revenue. Those revenues should be sufficient to be able to repay and service the debt. I think that is where the issue lies, we are taking out lots of debt for very inefficient investment ventures.


GVS: Building energy projects and roads, Is that inefficient? Aren’t these the factors that increase growth and productivity?

SS: If you are going to make a road which will for example around the world cost $1 million and here it is costing you $2 million then, of course, the value of the roads would cause the economy to go down. Similarly, the power projects if they’re overpriced and you end up paying a very high price, then the power that would be generated will not fuel the economic growth we’re looking for.

Because power is a basic input, which cannot be an expensive input compared to your competitors. So, if you are going to put money into projects of dubious benefits in terms of profits, in terms of revenues or in terms of cost then we are going to end up having lots of debt that we cannot service.

That is the danger in Pakistan. The project planning, the project approval systems, project monitoring systems are so bad that the government spending is rather inefficient. So, this is a big dilemma which faces the country which is also the debate which is now going on. Basically, corruption has turned up to be a very big factor in the debt issue.


GVS: What’s the thing that worries you for 2018? What do you think will be the biggest concern for Pakistan?

SS:  I think the power sector, to my mind, is the biggest concern, because when you end up with a power sector which is much more expensive than your competitors, then that means that most of your export sector will not be able to compete and a large area of the economy will then be damaged.

In the export sector, you can see that the textile industry is having a very bad time and similarly the agricultural sector has high costs. Those costs affect the agricultural exports and also affect its efficiency and the productivity. This will ultimately lead to higher agricultural prices for the people of Pakistan. As you can see that the price of wheat and the price of sugar is around 40-50% higher than the world prices which the consumers have to pay.

So, I think that the power sector is the Achilles heel of the economy. Before there was a shortage and the economy was suffering and now that you’re trying to limit that shortage but now the price of the power is so exorbitant that it will have a very negative effect on your productivity and competitiveness.