To have debt or not to have debt – by Ali Wahab
Source: Express Tribune
To have debt or not to have debt
by Ali Wahab
July 26, 2010
KARACHI: Every now and then we read statements or comments in newspapers and blogs that Pakistan’s economic situation is not good. Points that are highlighted include a “high” public debt, low tax-to-GDP ratio and “high” fiscal deficit of the country. Unfortunately, the facts are much different to what we are made to believe by commentators.
Pakistan’s total public debt was Rs8.160 trillion as of March 2010. This included both the domestic debt of Rs4.49 trillion and foreign currency debt of Rs3.67 trillion. As per the Economic Survey of Pakistan, using the above figures, our debt-to-GDP ratio was 56 per cent which would give us a GDP figure of Rs14.57 trillion approximately. This, when translated at current US dollar conversion rate, gives us approximately $170 billion as the GDP of Pakistan. If one was a little more skeptical and does not believe in the facts given by the ministry of finance, and adds a bit more to the total debt, we are looking at a figure of 62-65 per cent as debt-to-GDP ratio. The question is: “Is this high?”
Global data for 2010 is still not available as most of the countries follow January to December as the period for measurement of data. In order to have the right basis for analysis, let us look at the figures from 2009.
In 2009, Pakistan’s debt-to-GDP ratio was 46.2 per cent and our rank was 54th among 129 nations. The top 10 countries with the highest debt-to-GDP ratio included Japan ranked at number 2nd, Lebanon at 4th, Italy at 6th, Greece at 7th and Singapore at 8th. Our erstwhile neighbour and self-assumed rival, India, was ranked 34th with a debt-to-GDP ratio of 58 per cent. With the way things have panned out over the last six to eight months, the debt-to-GDP ratio of all the nations mentioned above for sure must have gone up.
At the same time, situation in India has reached alarming proportions. In a commitment to the nation in February 2010, Indian Finance Minister Pranab Mukherjee promised to bring the debt-to-GDP ratio down from 80 to 68 per cent by 2014. What India benefits from is a soft image it is able to portray and attract investment flows into the country. India turns weaknesses into opportunities for its own good. One can see advertisements enticing investors to invest in India which needs $500 billion over the next decade to continue on the path of growth. We, on the other side of the border, are unable to realise our potential and present the roughest possible image of the country abroad. The result is simple – foreign direct investment (FDI) was down 49 per cent as of March 2010. All other emerging markets of the world invite investors. We drive them away.
Why governments borrow
Coming to the point of this article, one has to question why governments need to borrow. Governments borrow to match the difference between their revenue and expenditure. Their revenue comes mainly from taxes and a small amount from returns on investments like dividends from state-owned enterprises or privatisation receipts. On the other hand, expenditures include running the entire government machinery, paying salaries, pensions, defence expenditures, debt servicing, etc. These expenditures are largely fixed ie you cannot do away with them entirely.
On the other hand, the expenditure that requires most attention is the development programme. Why it needs most attention is because the more you develop, the higher would be the multiplier effect on the economy. If the government builds a bridge over a river connecting two cities, the positive impact can be seen at numerous stages. For example, contractors will be appointed who will buy from suppliers, engage labourers for the project and pay taxes to the government (albeit small). After the bridge is built, the government can collect toll, recreation facilities like restaurants, fuel stations and rest areas will spring up which will also hire more people and so on. Hence, a spending of say Rs1 billion by the government will not just grow the economy of an area but will also recover money for the government in the form of direct and indirect taxes.
Now the question is where the problem lies in the greater scheme of things. Why are we not able to spend more on development? Why do we have the budget deficit? The answer lies in the fact that the taxes collected in the country are much lower than the prevalent average in the world. Unfortunately, Pakistan has one of the lowest tax-to-GDP ratios. In FY10, it was around 10.9 per cent whereas the number of taxpayers was estimated at around two million. In a nation of 170 million, it is a shameful number. On one hand, it reflects poorly on the ability of our governments and Federal Board of Revenue to effectively bring people under the tax net while the more worrying factor is that people do not want to pay taxes and use illicit means to protect their wealth.
I remember that after the arson that took place after the Ashura blasts in Karachi in December 2009, one could hear figures of losses of up to Rs30 billion to traders. It was most astonishing to note that only Rs1.6 billion was eventually claimed through the Karachi Chamber of Commerce and Industry. A number of traders were not willing to file claims for worries of cross-questioning by taxmen. And why should not they be worried? The affected traders had paid an amount of less than Rs100 million as income tax in FY09. Even the insurance companies reported ‘negligible’ insurance claims made by the affected traders. When you add all these up, it was not because they were uninterested in the compensation that they were looking for. It was the threat of prying tax officers that was a deterrent.
Calling a spade a spade
We can either keep on lambasting the government and FBR for their inability to bring people under the tax net or we can call a spade a spade and tax evaders as cheat. We need to ask ourselves “how can the government effectively spend on development when tax collection remains this low?”
Coming now to the point of increasing stock of debt owed by the government, there are issues that need to be pointed out. Firstly, we are in a war-like situation which has caused tremendous loss to the nation both in the form of economic loss as well as psychological loss. Secondly, we have to realise that because of such losses, we have seen a flight of capital from the country from the end of 2007 to early 2009. Thirdly, our currency’s loss against the dollar has caused a huge impact on the debt burden.
According to the Economic Survey 2009-10, since 1993, Pakistan has suffered an average translational loss (caused by the change in currency values) of approximately $248 million per year on our foreign debt. This means that every year because of our currency’s movement against the dollar, our foreign debt goes up by $248 million. The same has been very high since 2001 with a peak of $3.1 billion in translational losses suffered in FY08.
It is also sad to see that the government has so far failed to get any foreign exchange hedging mechanisms in place to limit these losses. In essence, Pakistan is a sitting duck with foreign exchange movements. The Economic Survey laments “that even in years where translational losses have been limited (ie 2005-2007), Pakistan has not been able to capitalise on favourable movements in international currency markets.” Since the end of March 2010, the rupee has fallen approximately 1.91 per cent against the dollar. During the last four months alone, our foreign debt would have gone up by approximately $1.2 billion.
Stringent plan needed
This is an unfortunate reality that our governments are forced to seek debt from the local market as well as international agencies, sovereigns, etc. It is also unfortunate that we are not able to focus on development expenditure which can help the government come out of its difficulties on a long-term basis and reduce the debt-to-GDP ratio and budget deficit. What we need is a stringent plan in which we are to contain our non-development expenditures and expand our development plans. This can happen by involving a number of experts, both having local knowledge and international experience to advise us with a suitable plan.
Most importantly, that plan has to be practical and should add value to the way we are managing our financial matters. I have previously pleaded for having a national campaign demanding a debt relief from foreign countries. They will only be inclined to give us relief if we are able to show them an executable plan that brings our house in order. And our house can only come into order if we expand the tax base, reduce non-development expenditure and most importantly begin and complete development projects that will have a multiplier effect on the economy and trickles down to the local level where development takes place.
We have to realise and ingrain this in outthinking that the success of people, and for that matter, nations should not depend on how well they do in good times, but how they are able to respond in times of challenges and move forward.
Published in The Express Tribune, July 26th, 2010.
very well written.
I find many urban commentator very casually says, these politician doesn’t have political will to collect tax money because they are not willing to give taxes themselves. this is so untrue its not like we had great tax-GDP ratio in past and suddenly its drop to all time low. the fact is tax culture was never there.
Atleast today politician are talking about importance tax collection .
Nice to see you coming out with the basic principles.You Set up a solid foundation!