Foreign borrowing is for the elite

Dr Muhammad Yaqub
Thursday, May 15, 2014

Every political party, when in opposition, criticises the sitting government for its poor economic management and reliance on foreign handouts to finance the budget and the balance of payments deficits. However, once in power, the same party follows the same script it was vehemently criticising while in the opposition.

Like previous governments, the PML-N government is doing the same. It was critical of the PPP government for its excessive domestic and foreign borrowing, and in the election campaign its leaders committed to break the begging/ borrowing bowl and restore national honour and sovereignty by pursuing a policy of self-reliance after coming to power. However, after taking over the reins of the government, it is engaged in a patchwork of its own based on massive foreign borrowing.

Unfortunately, this approach has the endorsement of the IMF which is pursuing its own agenda in Pakistan dictated by its own financial interests and political compulsions of its largest shareholders.

Thus, the underlying deterioration of the fundamentals of the economy is temporarily concealed through an unholy alliance that is helpful for the government and the IMF in the short run but harmful for the long-term interests of the economy and the people of Pakistan.

There is nothing wrong with borrowing when it is kept within prudent limits determined by the government’s ability to service and repay it both in rupee terms and in foreign exchange. It should also be a supplement, and not a substitute, for domestic tax and saving efforts meant to finance productive projects.

Similarly, privatisation is a sound policy if undertaken to improve efficiency of production of the poorly-run public-sector enterprises but not when it is used as a means to generate sale proceeds to temporarily ‘finance’ the structural budget deficit.

What the government is engaged in is reliance on foreign inflows to finance the budget and balance of payments deficits which will further contribute to the already heavy debt burden and mounting debt servicing liabilities. It is a self-defeating and potentially dangerous approach.

Its privatisation programme is also very slow-moving and the only transaction it may conclude in the foreseeable future is the sale of the remaining government shares of the United Bank. But when it does, its sale proceeds would be used to finance the budget deficit rather than to retire public debt. It would amount to mortgaging the future of the country through the sale of its profitable assets.

In a recent public presentation, Dr Hafiz Pasha, an eminent fiscal economist, explained how the present government, which promised to break the begging and borrowing bowl during its election campaign, has engaged in massive foreign borrowing since coming to power. He gave statistics to drive home the message that the PML-N government is in certain ways more reckless than the previous ones in resorting to borrowing but is fooling the people through a propaganda campaign into believing that the fundamentals of the economy are improving. The response of the Ministry of Finance to his excellent analysis of foreign borrowing was professionally misleading.

The increase in foreign exchange reserves of the State Bank of Pakistan (SBP), the appreciation of the exchange rate, the recent fall in government borrowing from the banking system and consequent increase in bank credit to the private sector and lowering of the recorded budget deficit are all paraded by the finance ministry as great economic achievements.


But the outwardly good-looking macroeconomic statistics conceal the real picture because all these apparent ‘improvements’ have their origin in massive inflows of foreign exchange in the recent past. Take out the impact of foreign inflows in the last ten months in all these areas and you will see the hollowness of the foundations of the economy and faulty economic management of the government.

If massive foreign borrowing/foreign grants/privatisation proceeds are taken out of the equation, the SBP would be without foreign exchange reserves, the budget deficit would be sky-high, government borrowing from the domestic banking system would be at an all-time record, the exchange rate will require a massive depreciation and there would be no liquidity in the banking system left by the government to provide credit to the private sector.

Pakistan is faced with three structural gaps between saving and investment, public sector revenue and expenditure and exports and imports. Their durable solution lies in structural reforms of the economy and not in arranging from abroad borrowing for temporary financing of those deficits. It solves the short-term liquidity problem of a sitting government but adds to the long-term insolvency of the country, thereby creating impediments to economic growth, inflation control and balance of payments sustainability.

The country requires a rate of investment of the order of 24-25 percent of the GDP to generate a growth rate of 7-8 percent that is needed to create new jobs to absorb the increase in the new entrants in the labour force. Currently, the domestic saving rate is around 12 percent of the GDP leaving a gap of 12-13 percent of GDP between the required rate of investment and the existing rate of domestic saving.

The sustainable solution of reducing the investment-saving gap is to reorient fiscal, monetary and exchange rate policies to gradually enhance the rate of domestic savings close to the required rate of investment. It requires an appropriate policy package to create incentives for savings and to curb conspicuous consumption both in the public and the private sectors.

That would be possible only if the running of the government falls in the hands of people motivated by considerations of national interest rather than those of vested interest groups. The present economic, social and cultural setup is not suited for such a major change in the economic and political governance structure of the country.

The result is that the investment level is way below that which is required to generate a growth rate of 7-8 percent and even then the national saving rate is inadequate to finance a very low level of investment.

The same is the story in the budget area. It has a structural public-sector deficit of the order of around 10 percent of the GDP caused by a narrow tax base and a low tax-to-GDP ratio, high burden of debt serving and defence, massive losses of the public-sector enterprises, large leakages of resources through corruption and pilferage and unsustainable structure of fiscal federalism.

The structural budget deficit can only be lowered by major fiscal reforms aimed to bring into the tax net the rich and powerful operating in the underground economy, industry, and agriculture and service sectors and relating provincial expenditure to their own tax effort. Unfortunately for the country, powerful interest groups have acquired political muscles and either directly rule the country or have an indirect ability to influence it so as to protect and promote their vested interests. As a result, the large structural fiscal deficit is being financed by internal and external borrowing which is being serviced and paid back by the poor through indirect taxation and inflation.

The import-export gap also remains very wide. The government has followed an import policy, developed a structure of customs duties and pursued an exchange rate policy that encourage imports and consumption and discourages exports and savings. Such a foreign trade framework suits the ruling elite to create and live in an island of prosperity within an ocean of poverty and economic deprivation.

The PML-N government is dominated by the rich and powerful groups of the country and does not want to bring them into the tax net by expanding the tax base and eliminating the tax loopholes. The government is under the influence of vested interest groups in its formulation of policies, wishes to man and manage economic institutions subserviently and fools the poor to continue to remain in power.

There is a need for the majority of people to pierce through the veil of deception and dacoity that has been woven by the ruling elite to exploit the country’s economic resources for self-enrichment rather than for economic welfare of the majority.

The writer is a former governor of the State Bank of Pakistan.Email: [email protected]

The News,Pakistan.