Determinants of Public Debt Growth within Pakistan

"I place economy among the first and most important virtues, and public debt as the greatest of dangers. To preserve our independence, we must not let our rulers load us with perpetual debt."
                                                                                                            -Thomas Jefferson-

 Public debt is the sum of governmental financial obligations; which are the result of a state’s borrowing from its population, from foreign governments or from international institutions. Public debts tend to be large-scale credit operations and are contracted on a national scale by central governments and on a lesser scale by provincial, regional, district and municipal administrative authorities.

             National public debts are contracted mainly by incurring interest paying loans, in the form of bonds, bills or notes. Governments have taken loans to meet national budget or expenditures that remain uncovered by revenues; or to seek to improve economic conditions by counteracting unemployment or depressions, or both with deficit budgets. Not all financial authorities agree that nations should carry a high level of public debt, as it can be inflationary. Rather than the level of debt, however, the most important consideration is the capacity of a nation to service its debt.

             Some long term maturing debt is repaid by short-term borrowing that does not add significantly to the total debt level. The redeeming of public debt includes the repayment of principal on maturity, amortization through periodic payment of part of principal, and the buying up of government securities on the open market. Most government loans fall due at fixed dates, but some perpetual loans have no definite expiration dates, and governments floating them have the privilege of redeeming them when desirable.

             Most government loans are not secured by physical assets, however they are regarded in law as contracts carrying an obligation on the part of the debtor to repay, nevertheless governments when hard pressed during economic crises or as a result of political upheavals, have sometimes refused to repay their public debts.

 In a broader macroeconomic context for public policy, governments should seek to ensure that both the level and rate of growth in their public debt is fundamentally sustainable, and can be serviced under a wide range of circumstances while meeting cost and risk objectives. Sovereign debt managers share fiscal and monetary policy advisors' concerns that public sector indebtedness remains on a sustainable path and that a credible strategy is in place to reduce excessive levels of debt. Debt managers should ensure that the fiscal authorities are aware of the impact of government financing requirements and debt levels on borrowing costs.[1] Examples of indicators that address the issue of debt sustainability include the public sector debt service ratio, and ratios of public debt to GDP and to tax revenue.

 Poorly structured debt in terms of maturity, currency, or interest rate composition and large and unfunded contingent liabilities have been important factors in inducing or propagating economic crises in many countries throughout history. For example, irrespective of the exchange rate regime, or whether domestic or foreign currency debt is involved, crises have often arisen because of an excessive focus by governments on possible cost savings associated with large volumes of short-term or floating rate debt. This has left government budgets seriously exposed to changing financial market conditions, including changes in the country's creditworthiness, when this debt has to be rolled over. Foreign currency debt also poses particular risks, and excessive reliance on foreign currency debt can lead to exchange rate and/or monetary pressures if investors become reluctant to refinance the government's foreign-currency debt. By reducing the risk that the government's own portfolio management will become a source of instability for the private sector, prudent government debt management, along with sound policies for managing contingent liabilities, can make countries less susceptible to contagion and financial risk.

A government's debt portfolio is usually the largest financial portfolio in the country. It often contains complex and risky financial structures, and can generate substantial risk to the government's balance sheet and to the country's financial stability. As noted by the Financial Stability Forum's Working Group on Capital Flows (USA), "recent experience has highlighted the need for governments to limit the build-up of liquidity exposures and other risks that make their economies especially vulnerable to external shocks."[2] Therefore, sound risk management by the public sector is also essential for risk management by other sectors of the economy "because individual entities within the private sector typically are faced with enormous problems when inadequate sovereign risk management generates vulnerability to a liquidity crisis." Sound debt structures help governments reduce their exposure to interest rate, currency and other risks. Many governments seek to support these structures by establishing, where feasible, portfolio benchmarks related to the desired currency composition, duration, and maturity structure of the debt to guide the future composition of the portfolio.

 Several debt market crises have highlighted the importance of sound debt management practices and the need for an efficient and sound capital market. Although government debt management policies may not have been the sole or even the main cause of these crises, the maturity structure, and interest rate and currency composition of the government's debt portfolio, together with substantial obligations in respect of contingent liabilities have often contributed to the severity of the crisis. Even in situations where there are sound macroeconomic policy settings, risky debt management practices increase the vulnerability of the economy to economic and financial shocks. Sometimes these risks can be readily addressed by relatively straightforward measures, such as by lengthening the maturities of borrowings and paying the associated higher debt servicing costs (assuming an upward sloping yield curve), by adjusting the amount, maturity, and composition of foreign exchange reserves, and by reviewing criteria and governance arrangements in respect of contingent liabilities.

 Risky debt structures are often the consequence of inappropriate economic policies--fiscal, monetary and exchange rate--but the feedback effects undoubtedly go in both directions. However, there are limits to what sound debt management policies can deliver. Sound debt management policies are no solution or substitute for sound fiscal and monetary management. If macroeconomic policy settings are poor, sound sovereign debt management may not by itself prevent any crisis. Sound debt management policies reduce susceptibility to drawbacks and financial risk by playing a pivotal role for broader financial market development and financial deepening. Experience supports the argument, for example, that developed domestic debt markets can substitute for bank financing (and vice versa) when this source dries up, helping economies to weather financial shocks.[3]

 Literature Review:

            Over the years, ever piling domestic debt was less of a concern as compared to the external context of debt. However, during the last decade this topic has occupied primal importance not just in the local but also in the international arena.

            Flowers 1989, was certainly the first one to discuss the constitutional politics of public debt. Even before this Buchanan and Roback 1987 explored the implications of public debt in a world populated simultaneously by some individuals willing to leave positive and others wishing to leave negative bequests. However, this was a mere theoretical review with application not possible across countries. A deregulated picture was given by Lott 1990, where the discussion was quite rich as regards the predation by public enterprises. Another scenario integrating public debt, deficits, and inflation is observable in Buiter and Patel 1991. This analysis was fundamentally a case study of India, but provided important insight for the operational predicaments being faced by the emerging third world countries.

            Burney 1988 for the first time came up with certainly the most comprehensive study regarding the debt problem in Pakistan and its debt servicing capacity. After this, there were several writings, but most of them were only the warning signals for the rising external commitments. Precisely this was also the time when government resorted to domestic borrowing, whose repayment was latter to become an enigmatic dilemma. Tahir 1998 discussed the present plus the predicted positions of internal and external debt. (This paper will be discussed in quite a detail under latter headings). Another forecast of future trends was made available in Ahmed 1998. Over here, the author has projected that in 1997-98 the internal debt (41.51% of GDP) was greater than External debt (31.11% of GDP). But as the capacity of internal resources dry out the position of 2019-20 will be that the External debt (69.33% of GDP) will be considerably higher than internal debt which is estimated to be about 33.22% of GDP.

             Another recent effort can be observed in Hassan 1999; where the changing nature of Pakistan’s debt problem has been elucidated (in a manner, so as to show the evolution of the debt problem).

 Historical perspective and the present burden of Public Debt:

             Pakistan during the last half century started from the scratch primarily as an agrarian economy to be transformed into a semi-industrialized state. Golden 60s was a period of amazing economic growth, due to factors like massive foreign aid, imports substititution (for manufacturing sector), green revolution, increased rewards in the private sector etc. The era of 70s brought about great economic and political distress for the citizens in the form of; breakup of Pakistan, initiation of a mismanaged nationalization policy, oil shock, trade balance deficit (due to deterioration of terms of trade) etc. Yet, the decade was somehow sustained and the gap reduced; attributable to a mega rise in workers remittances from Gulf.

            Early 80s also witnessed the remittance flow that provided a breathing space to an economy about to witness fundamental changes. Trade liberalization was the new direction complimented by the adoption of flexible exchange rate regime.[4]  This was the starting point in the downfall of one of the fastest growing developing nations. In mid 80s the deficit (fiscal) increased to 8% of GDP, as the rising government expenditures levied its toll. This in turn led to a soaring of external and domestic borrowing. Ultimately this borrowing was to cripple the nation’s progress in future. Despite manufacturing sector’s expansion and booming domestic market, late 80s witnessed a deepening of the balance of payment crises. On one side the economy was being injected with increased benefits from illegal trade income (partly due to Afghanistan crises), while on the other end large debt servicing, saturating trend in investment and savings plus the decreasing inflows started to set in.[5] By 1990 civil war in Karachi hindered the manufacturing capacity of the largest industrial city of Pakistan in regretting manner.

As compared to the foreign aid, acquiring of public debt was a relatively new phenomenon (see table I). Infact it was during Zia regime, when the public debt grew six folds (at a real average annual rate of 10%). At this time, the main source of growth in real debt was the expanding of primary deficit. In turn these persistent fiscal deficits have resulted in exponential growth of debt servicing. By 1998-99, the proportion of interest payments to revenues rose to well over 40%. 

As the 90s closed their account, the world saw a failed case of democracy in the shape of Pakistan’s political and economic trauma. During the whole of 90s decade until now governments could do nothing to improve the expenditure side let alone the incomes side that was to derive impetus with the right mix of development and productive expenditure. Today the country faces three major cost yielding burdens:

                                 i.            Debt Servicing,

                               ii.            Military expenditure,

                              iii.            Establishment costs.

Deepening of debt problem has hollowed the economic stabilization mechanism. As far as the external debt is concerned, Pakistan has help of multilateral agencies in the form of rescheduling and rollovers. On the contrary, domestic debt has started to pose multidimensional problems. While the ratio of public debt to GDP increase to over 100% in 1998-99, the ratio of debt to revenues increase to 600%, along with the proportion of interest payments to revenues climbing well over 40%.[6]

At present, the giving of a judgment of Pakistan’s existent economic position becomes even difficult where we have weak executioners. Although the present government has made apparent efforts towards objectives like the implementation of transparent financial reforms, documentation of economy (through nation wide tax survey, with a view to broaden he general sales tax net), anti-smuggling trade measures, cut in establishment costs, curtailing the military expenditure etc. but the tangible rewards of the aforementioned efforts have yet to be sighted.

We can observe from table 2, that the general economic factors that went against the scenario also aggravated the debt problem. The real revenues show a saturated position. Three reasons can be classified for this trend. First major reductions in income tax, sales tax and the customs duty rates lowered the tax base.

Secondly, the persisting governance problem has weakened the compact between the state and citizens, thus leading to a growing resistance towards paying taxes.

            Thirdly, the increase in revenues in the 1980’s relying heavily as it did on foreign trade taxes was not sustainable. Over here, we would also like to discuss the role of interest rates (see table 4). Until 1980’s most of government borrowing was acquired at a level below market rates. Then after ’89 as a part of World Bank supported financial sector reforms, the move towards a market based interest rates determination lost its target due to the accelerated inflation. Meanwhile governments have also resorted to non-bank sources for borrowing. The introduction of various savings schemes has been an episode in the non-bank sources. (Under these schemes as well, the interest and inflation rates levied their toll).

A worth noticing phenomenon in Table 3 in the extraordinary increase in Public Debt to revenue percentage. If we simply relate this ratio to the rise in deficits (table 2), then one realizes that this sharp upward trend has certainly forced the economic forecasters to sign in a very bleak picture for future.

Methodology:

            National or public debt comprises of two brackets:        I- Internal or Domestic Debt

                                                                                               II- External debt

Both these categories demand isolated analysis not in the partial sense but in the context of empirical interdependence. For this purpose, we would first take Model 1 for the evaluation of: “Determinants of growth in External debt”.

For simplicity, we will deduce the growth determinants as exhibited by the ‘ratio of External debt to GDP’. This working has been adopted from the works of Swender Van Wijenbergen 1989.

Then in Model 2, we would extend Swender’s model for deducing the determinants of growth in domestic debt of Pakistan. We must also bear in mind that several of these determinants depict a correlated behavior towards each other. This intensity of correlation needs critical investigation.

            As for now we take up two important issues:

                        i) The debt trap; as seen in the chart, the accumulation of debt is not merely an isolated process resulting from a short fall of revenues in comparison with the expenditures, but it is a very integrated process which is complemented by two other factors namely, the debt servicing and the borrowings.

 ii) The treatment of budget deficits (which are of course the main cause of debt accumulation) also needs to be considered from the view point of National accounts. The basic accounting identity for deficits is as follows:

Budget deficit = Primary Budget Deficit + Interest Payments on outstanding Public Debt

           For the financing of budget deficits, consider the following equation:

Budget Deficit = Money Printing + Foreign Reserve Use + Foreign Borrowing + Domestic Borrowing   

For the acquiring of debt governments at different levels, make use of several instruments. The major Public debt instruments (in Pakistan) and their characterstics are available in Appendix II.

            Model 1:

            We focus in this model on the changes in the External Debt to GDP ratio, and the factor responsible for these changes.

Consider the following expression by Swender van Wijenbergen 1989:

Where ‘De’ is the external debt, ‘E’ the exchange rate, NICAD = non-interest current account balance, ‘y’ = GDP, ‘r’ is the real interest rate on external debt, and ‘g’ is the real GDP growth. So that the equation implies:

Absolute change in external debt = (Noninterest current account deficit) + (interest payments on external debt) + absolute magnitude of capital loss on external debt (due to exchange rate)

Thus the equation reveals that the change in the external debt to GDP ratio is attributable to three factors as follows:

i)                                            The non-interest current account balance. The larger the deficit in the current account of the balance of payments, excluding interest payments, the greater the increase in the external debt due to larger borrowings;

ii)                                           The extent to which the real interest rate, r, on the foreign debt exceeds the growth rate, of the economy;

iii)                                         The rate of capital loss on external debt due to real exchange rate depreciation, dE/E[7]

Results of the application of the methodology in equation (1) have been exhibited in the Appendix I. Over here, we outline the main interpretations of our empirical work in the perspective of policy implications as follows:

The pattern of change in the external debt differs fundamentally between the decade of the 80s and the 90s. In the former period, the cumulative increase in the ratio was about 13.5 percentage points (appendix 1), whereas in the first half of the decade of the 90s there was an overall fall of 5.7 percentage points. The second half of the 90s again saw a dramatic increase in the foreign debt burden more so due to the servicing costs. What needs to be clearly seen over here is; why has there been greater success in curtailing the external debt burden in the first half of the 90s despite the sharp fall in the real growth rate of the economy? The main reason for this is the difference in the rate of real exchange rate depreciation and not in the size of the current account deficits (appendix1). During the 80s Pakistan followed an aggressive exchange rate policy which actually led to increasing under valuation of the rupee in terms of purchasing power parity, and the real exchange rate fell on average each year by as much as 2.8 percent. This implied major capital losses and rapid increases in the rupee value of external debt. On the contrary, during the first half of 90s the rupee has moved, more or less, in line with changes in purchasing power parity with only marginal changes in the real effective exchange rate (appendix 1). One again observes a jump in the external debt/GDP ratio due to the continued devaluation starting from November 1995.[8]

The nature of our analysis completely changes in the latter half of 90s until now. We encounter a change in the determinants of foreign debt burden in a manner that diverts our attention from the deficits and exchange rate effects and drives the focus upon the mega interest payments taking the shape of debt servicing. As it is evident from the results, that interest payment on external debt has the highest coefficient value with the most significant t-statistic result.[9] Similarly after 1995, we also observe an increasing trend in the current account deficit (non interest), which also adversely affected the extent by which Pakistan was dependent on foreign sources of borrowing. Even in the early 80s, it can be recognized that the current account deficits could have increased the magnitude of effect on the external debt to GDP ratio, but this feared increase did not take place due to the fact that throughout the period the real interest rate on external debt was substantially below the real growth rate of economy (Table 2). In that era, the access of Pakistan to concessionary financing from multilateral and bilateral agencies has been a major factor responsible for restricting the level of external debt to GDP ratio.

 Model 2

             Total debt ‘D’ is composed of Dd i.e. the domestic debt and the ‘DeE’ i.e. the external debt (multiplied by the exchange rate change ‘E’) as shown in equation 1.

                         D = Dd + DeE                                                                          1

 In equation 2 we open up the 1^st equation to see the combined determinants of both types of debt.

                                  2

Where, PBD is the Primary Budget Deficit, while the rest of the notations are same as above.

            Thus from equation 2 we take out those factors that have contributed towards the domestic debt. In addition to those factors we also make the real inflation rate responsible as in the 3^rd equation below:                      

Dd = f (PBD + Interest payments + inflation rate)                         3

Results of the analysis based on equation 3 are as follows:

    Primary budget deficit generally, is identified as a determinant of overall national or public debt. We over here regard primary budget deficit as the main factor that has contributed towards an increase in the domestic debt earlier on. As for the latter part, the main culprit will be the interest burden on the internal debt that made the matters worse off. There was a sharp increase in the public debt to GDP ratio by almost 28 percent between 1980-81 and 1994-95, with most of the increase in domestic debt. As pointed out earlier the major factor contributing to the rise in the debt was the cumulative effect of successive large primary budget deficits. This trend slowed down as the actual size of deficit in relation to the GDP declined in the first half of the 90s. But this is precisely the time when we encounter a noticeable jump in interest payments on almost all types of domestic debt (in 1991-92). This rise can be attributed to the financial sector liberalization, leading to an institution of market based interest rate structure in government debt instruments like treasury bills.

            However, the actual rate of domestic debt growth, which in 80s was 22 percent, declined to 16 percent in the first half of 90s. However, this was not to remain the same in the latter years of 90s, when until 1998 the domestic debt soared to a little less than two fold as compared to the level of 1994.

             The rapid rise in interest payments on domestic debt has resulted in a structural change in the pattern of interest payment in the country. In 1980-81, over 40 percent of the interest paid, was on external debt. This proportion has fallen down to 23 percent. Within domestic debt, the share of interest payments on unfounded and permanent debt have increased over time while the significance of provincial interest payments has declined.

Ø      From the policy desk now the strategy will have to be geared towards interest payments on domestic debt both because of the gravity of the problem and the relatively higher scope of improvements on the domestic side.

Ø      At the least now the policy goal must be to keep the public debt to GDP ratio constant. Otherwise, there is the danger that a rising ratio coupled with higher interest rates, accompanying the process of financial sector liberalization would make the situation unsustainable.

Ø      The key policy objective of fiscal management must therefore be to keep the primary budget deficit at a level, which prevents the public debt to GDP ratio from rising.

Ø      (As for the external debt) the exchange rate policy will have to be motivated not only by the consideration of keeping current account deficits at a sustainable level but also by the need to limit capital losses on external debt which increase debt servicing obligations in Ruppee terms.

Ø      Thus based on the above considerations the Swender equation can be a tool to ensure that the public debt to GDP ratio does not rise beyond the present level. (If change in D/Y = 0), thus if the primary budget deficit remains below 1.5 percent of the GDP annually then the public debt to GDP ratio is unlikely to rise significantly beyond its current level (see Appendix I). However, the degree of structural adjustment in public finances may not be adequate if the intention is to keep the level of interest payments to GDP constant.[10] Thus, there would be a need to target a broader definition of these adjustments.

Issues and Strategies for Future debt management:

• There is an immediate need to demonstrate clearly better macroeconomic management during the next five years. This will require an integrated effort towards four directions:
1. An exhibition of austerity at all levels of society,
2. Expanding the base of government revenues (especially the export content),
3. Eliminating or at least reducing the excess of current government expenditures over revenues.
4. Improving the quality of recourse use in the public sector.

• The macro economic management would have to be complimented by continued fiscal adjustment. This adjustment should not be achieved on the cost of a cut in development spending. The objective should be not only be to reduce the deficit but also to transform negative government savings in to a positive proportion of GDP. This increased domestic savings will increase confidence in the currency, reducing the need for frequent devaluations and will also prevent capital flights.
• The critical importance of tax revenues needs to be stressed. There is a definite need to expand the General Sales Tax net. We are still in need of a formula that could blend a fair system of taxation without making any hindrance for justified profits and growth. The documentation of the economy will prove to be a step in the right direction only if its implementation does not take too long. We have about four years to go before the WTO levies its crunch. Until then, we must focus on restricting the imports of unnecessary items, by levying some rational set of excise duties. Towards the attainment of this goal, the rich class of the society will have to play a pivotal role, as they are the main contributors in luxury imports, which certainly have adverse effects on the exchequer.
• Presently privatization proceeds may be the most tangible source for debt retirement. Privatization process in Pakistan has been very sluggish and in order to correct this pattern their is a definite need to accelerate the selling of possible units for four important reasons:
1. Getting rid of sick and cost yielding projects,
2. Improving efficiency in the economy,
3. Allowing transparency in reforms,[11]
4. Achieving a revenue increase amounting to Rs.200 billion.

• As indicated in the table 4, high real interest rate was the primary cause of further sharp growth in debt during the end of period under consideration.  At present we are tied up with mega commitments in the form of interest obligations internally as well as externally, but we present over here a future line of action as to have better control over the interest bearing public debt instruments. Following are some of the risks encountered in debt transactions. It becomes very imperative to at first understand the different nature of these risks in their operational context:

 Thus, it is imperative for the authorities as for now to take care of different types of risks involved when considering the feasibility of perpetual interest payments involved.

• Another danger involved in the debt transactions is the risk associated with the volatility of exchange rates. This factor alone has accounted for the deterioration of debt scenario for many third world countries. Excessive unhedged foreign exchange exposures can take many forms, but the predominant is directly issuing excessive amounts of foreign currency denominated debt and foreign exchange indexed debt. This practice may leave governments vulnerable to volatile and possibly increasing debt service costs if their exchange rates depreciate, and the risk of default if they cannot roll over their debts. This has actually happened with Pakistan as is visible from Appendix 1, that during the times of early 80s when Pakistan remained indifferent towards the debt pile up, and had no control on the level of international inflation, then the real devaluation of currency became necessary to correct the structural instability in the balance of payments.
• This aforementioned apprehension also calls for an effective policy mix of monetary and fiscal sides. Both Ministry of Finance and the State Bank of Pakistan need to interact now on matters such as debt swapping and forwarding, whenever in danger of capital loss.[13]The main objective of public debt management is to ensure that the government's financing needs and its payment obligations are met at the lowest possible cost over the medium to long run, consistent with a prudent degree of risk. Prudent risk management to avoid dangerous debt structures and strategies (including monetary financing of the government's debt) is crucial, given the severe macroeconomic consequences of sovereign debt default, and the magnitude of the ensuing output losses. These costs include business and banking insolvencies as well as the diminished long-term credibility and capability of the government to mobilize domestic and foreign savings.

• Speaking in the context of external debt, four other aspects of debt management policy deserve attention.[14] First, the objective should be to strongly discourage additional short-term resident currency deposits and to phase out the existing ones by converting them to longer-term obligations. The latter should be treated as a part of the external debt. Second in dealing with external debt, other foreign exchange obligations notable those related to resident foreign currency deposits and bonds issues in lieu of these deposits and obligations relating to e.g IPP’s must be explicitly taken into account in the context of a medium term balance of payments projection. Third, the foreign exchange reserves should be increased from the present level of little over one month to at least two months of foreign exchange payments. The build up of foreign exchange reserves and the phasing out of short term foreign currency deposits will not necessarily have a negative impact on foreign exchange availability because it is likely to increase the flow of worker remittances and improve the prospect of obtaining short term flows from the international banking system. Finally, the foreign exchange revenues that may be available form privatization i.e. sales of assets to foreigners should be earmarked for reduction rather than for current use, paralleling the policy for retirement of public debt.

• As mentioned above the fiscal policy advisors and central bankers should share an understanding of the objectives of debt management, fiscal, and monetary policies given the interdependencies between their different policy instruments. Debt managers should convey to fiscal authorities their views on the costs and risks associated with government financing requirements and debt levels. Where the level of financial development allows, there should be a separation of debt management and monetary policy objectives and accountabilities. Debt management, fiscal, and monetary authorities should share information on the government's current and future liquidity needs.

 Transparency and Accountability:

The allocation of responsibilities among the ministry of finance, the central bank, or a separate debt management agency, for debt management policy advice, and for undertaking primary debt issues, secondary market arrangements, depository facilities, and clearing and settlement arrangements for trade in government securities, should be publicly disclosed. The objectives for debt management should be clearly defined and publicly disclosed, and the measures of cost and risk that are adopted should be explained.[15] The public should be provided with information on the past, current, and projected budgetary activity, including its financing, and the consolidated financial position of the government. The government should regularly publish information on the stock and composition of its debt and financial assets, including their currency, maturity, and interest rate structure. External auditors should audit debt management activities annually.

            Institutional Framework

The legal framework should clarify the authority to borrow and to issue new debt, invest, and undertake transactions on the government's behalf. The organizational framework for debt management should be well specified, and ensure that mandates and roles are well articulated. Risks of government losses from inadequate operational controls should be managed according to sound and prudent practices, including well-articulated responsibilities for staff, and clear monitoring and control policies and reporting arrangements. Debt management activities should be supported by an accurate and comprehensive management information system with proper safeguards.

Staff involved in debt management should be subject to a code-of-conduct and conflict-of-interest guidelines regarding the management of their personal financial affairs. Sound business recovery procedures should be in place to lessen the risk that debt management activities might be severely disrupted by natural disasters, social unrest, or acts of terrorism. The risks inherent in the structure of the government's debt should be carefully monitored and evaluated. These risks should be mitigated to the extent feasible by modifying the debt structure, taking into account the cost of doing so. In order to help guide borrowing decisions and reduce the government's risk, debt managers should consider the financial and other risk characteristics of the government's cash flows (e.g. see appendix II). Debt managers should carefully assess and manage the risks associated with foreign-currency and short-term or floating rate debt.

There should be cost-effective cash management policies in place to enable the authorities to meet with a high degree of certainty their financial obligations as they fall due. A framework should be developed to enable debt managers to identify and manage the trade-offs between expected cost and risk in the government debt portfolio. To assess risk, debt managers should regularly conduct stress tests of the debt portfolio on the basis of the economic and financial shocks to which the government--and the country more generally--are potentially exposed. Debt managers who seek to manage actively the debt portfolio to profit from expectations of movements in interest rates and exchange rates, which differ from those implicit in current market prices, should be aware of the risks involved and accountable for their actions.

Debt managers should consider the impact that contingent liabilities have on the government's financial position, including its overall liquidity, when making borrowing decisions. [16]  In order to minimize cost and risk over the medium to long run, debt managers should ensure that their policies and operations are consistent with the development of an efficient government securities market. The government should strive to achieve a broad investor base for its domestic and foreign obligations, with due regard to cost and risk, and should treat investors equitably. Debt management operations in the primary market should be transparent and predictable. To the extent possible, debt issuance should use market-based mechanisms, including competitive auctions and syndications. Governments and central banks should promote the development of resilient secondary markets that can function effectively under a wide range of market conditions.

We close in on the paper by a very striking picture of Pakistan economy shown in an article of the Daily News, that demands much more efforts than policy recommendations by  the executives, and what is more to say accept the very fact that if our executioners make a delay, this debt burden is indeed bound to sink the next generations to come.

Appendix 1

Analysis of factors contributing to the growth in External Debt

Where:

Result:

 Total Burden of External Debt = -291331     (+46.1)Eint.    (+0.11)Exc      (+0.2)CD       

 C (intercept) = -291331

Eint = Interest payments on the External Debt.

Exc = (effect of ) Real implied Exchange rate.

CD = (non interest) current account deficit.

Where all three variables positively affected the overall External debt but, only “interest payment on External debt” stands statistically significant at a t-statistic of 17.46. Other parameters led to only marginal effects on the external debt during the period 1981-99.

Results:

Total Burden of Domestic Debt = 133640.7  (+1.71) Inf.*   (+6.87) D.Int.  (+0.91) PBD

Where R², the goodness of fit = 0.99 (Perfect fit);

Durban-Watson-Statistics = 1.99 (Almost equal to 2, which implies no Positive Autocorrelation).

*Inf. = Inflation as expressed by GDP Deflator.

D.Int. = Interest Payment on domestic debt.

PBD = Primary Budget Deficit.

C (intercept) = 133640.7

All three variables are statistically yielding a positive significance as indicated by the t-statistic.

For elucidating our empirical analysis, it is imperative that we also investigate the correlating effects with in the variables themselves, so as to judge the future pattern and base our estimating which is isolated from divergent effects. Following are the correlation matrices of the independent and dependent variables

Correlation Matrix for the variable affecting External Debt

Correlation Matrix for the variables affecting Foreign Debt

Debt expressions as in Descriptive Statistics

                                                                                                            Appendix II

By: Vaqar Ahmed

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