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Economy

Interest payments consume one-third of Pakistan's budget

Over-reliance on loans bodes ill for fiscal sustainability and domestic needs

Pakistan is pouring increased amounts of money into servicing loans, which bodes ill for domestic spending on health care, infrastructure and other areas.   © Reuters

KARACHI -- Fiscal sustainability has become a major issue among political and economic analysts after Pakistan revealed early this month that servicing debt accounts for more than one-third of its federal budget.

Finance Minister Shaukat Tareen in the National Assembly on June 12 announced the fiscal 2021 federal budget of 8.48 trillion rupees ($54 billion). Interest payments on debt, which are expected to grow by 3.9% from the ongoing fiscal year, account for 3.06 trillion rupees, or 36% of budget expenditures. In contrast, the government is only spending 600 billion rupees on subsidies and 100 billion rupees for COVID-19 vaccinations and emergencies.

The budget also reveals a deficit of 3.99 trillion rupees. The federal government plans to borrow 3.74 trillion rupees to finance this deficit, which makes up 94% of the deficit.

Pakistan's reliance on debt is a violation of the country's Fiscal Responsibility and Debt Limitation Act 2005, which states that the government must limit debt to 60% of gross domestic product. Currently, the ratio stands at 78% of Pakistan's $303 billion GDP.

Hasaan Khawar, a public policy analyst based in Islamabad, says Pakistan borrows heavily not only to finance current expenditures but also to service existing debt. "Pakistan is a having a primary fiscal deficit. That's why the [International Monetary Fund] has been demanding a primary budget surplus so that it starts reducing debt."

Khawar, who is also the team leader of the Sustainable Energy and Economic Development Program for Khyber Pakhtunkhwa Province, told Nikkei Asia that borrowing can only be sustainable if the interest rate is lower than the return on investment, a strategy that would help the economy to grow. He said that over the last couple of years, development spending has been reduced to meet fiscal targets set up by the IMF, which has hindered projects that directly affect people's welfare.

"Resources that could have been spent on essential sectors like health, education or public investment are now being dedicated to interest payments," said Naafey Sardar, a senior research associate at Texas A&M University in the U.S., emphasizing that increased debt financing presents a trade-off for Pakistan. "Since increased public investment and expenditures on education and health are associated with improvements in economic growth, higher debt financing expenditures reflect a missed opportunity," he said.

Of the 3.06 trillion rupees earmarked for interest payments on debt, 2.76 trillion rupees, or 90%, will go toward servicing domestic debt.

A senior official involved with the government's development planning told Nikkei on condition of anonymity that domestic borrowing is unsustainable. "Domestic borrowing is always at high commercial rates and external borrowing is mostly at concessional rates. That's why domestic borrowing costs the economy more," the official said.

On June 10, the Financial Times quoted Tareen as saying that Pakistan will leverage military cooperation with the U.S. in Afghanistan to gain concessions in a deal with the IMF. The finance minister later denied the report.

"Given its financial condition, Pakistan is left with no choice but to use its geostrategic advantages to get concessions from the IMF in the form of more loans," the anonymous official said.

In order to deal with the deficit, Pakistan has to either reduce government expenditures or increase taxes. "Reducing government expenditures will slow infrastructure development and economic growth," the official said. "But increasing taxes means the government has to target the elite, which forms the support base of the government." The official concluded that the situation has created a huge dilemma.

Experts believe that a combination of reduced government spending and a tax increase is the solution.

Sardar believes that the way out is to increase tax revenue. "Higher tax receipts can be earned by increasing the corporate tax rate from 29% to 35%," he said. Sardar added that at a time when corporate profits are surging, increasing corporate taxes could be a viable option.

Khawar believes that Pakistan can accrue surpluses by controlling fiscal waste. He says there is a multipronged strategy to deal with the problem. "Government needs to widen the tax base using technology for tax enforcement while reducing expenditures in loss-making state-owned enterprises," he said. "There is no quick fix to this. That's the bottom line."

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