Dependence on loans and aid is never a good sign for any economic forecast. Pakistan has been heavily relying on foreign aid and loans namely from the IMF, ADB since its inception, particularly after the loss of its most productive provinces of East Bengal in 1971.
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Such dependence on external debt can have a crippling effect on the inner workings of a sovereign state, namely in the formation of its foreign and domestic security and financial policy. Pakistan has gone to the IMF for bailouts a record 15 times. It borrows heavily not only to finance current expenditures but also to service existing debt, i.e accumulating more debt to pay previous debt. This can detract Foreign Direct Investment (FDI), hurting the economic indicators
Let’s firstly define what external or foreign debt actually is, in the context of nation states. Foreign debt is money borrowed by a government, from another country’s government or private lenders or international organizations. Foreign debt includes obligations to international lending organizations such as the World Bank, Asian Development Bank(ADB), and the International Monetary Fund (IMF).
The pecking order theory of Finance in this regard needs to be looked at. This theory formulates an order through which a business should optimally finance itself. The first avenue in this “pecking order” is through retained earnings or self-finance If this source of financing is unavailable, only then a company should then finance itself through debt. Pakistan is currently doing the opposite of this.
Pakistan’s current foreign debt condition is a miserable one. Our Debt to GDP ratio is a staggering 77%, behind India’s 69% and Bangladesh’s 34%. By comparing what a country owes with what it produces, the debt-to-GDP ratio reliably indicates that particular country’s ability to pay back its debts. The higher the ration, the less likely it is to pay back in the foreseeable future.
In mid 2021, Pakistan’s 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, account for 3.06 trillion rupees, or 36% of budget expenditures, meaning one third of the fiscal budget goes to servicing external debt.
Studies and research papers have proven that excessive levels of foreign debt can hamper countries’ ability to invest in their economic future—whether it be via infrastructure, education, or health care—as their limited revenue goes to servicing their loans. This thwarts long-term economic growth. Moreover, it reduces the level of private fixed capital formation in the country. Exploring the role of investment towards economic growth, we find that both the foreign direct investment and the fixed capital formation help these economies to grow,
High levels of foreign debt have contributed to some of the worst economic crises in recent decades, including the Asian Financial Crisis and, at least in the case of Greece and Portugal, the Eurozone debt crisis.
So what are some of the solutions to this massive economic conundrum Experts have suggested numerous solutions specifically for the Pakistani situation. Firstly, the government can issue debt with bonds. In a first, Pakistan raised $2.5 Billion in international bonds in 2017, and has since been able to raise such amounts in subsequent years. This enables the government to avoid raising taxes and provides money to pay expenditures, while also stimulating the economy through public spending, theoretically generating additional tax income from prosperous businesses and taxpayers.
Another solution is playing with the interest rates. Maintaining interest rates at low levels is another way that governments seek to stimulate the economy, generate tax revenue, and, ultimately, reduce the national debt. Which at present is at 8.75%, which is comparatively lower than it has been in previous years.
Though the most effective solution for Pakistan is to raise tax collection. Pakistan has one of the lowest tax collection rates in the world. It is estimated that only 0.6% or 1 million people out of a population of 220 million are registered to pay their taxes. Taxes can include federal, state, and in some cases, local income and business tax. Other examples include the alternative minimum tax, sin taxes (on alcohol and tobacco products), corporate tax, estate tax, Federal Insurance Contributions Act (FICA), and property taxes. This will provide a bonafide source of revenue reducing dependence on foreign debt.
Experts have also suggested that in Pakistan’s case, addressing overpopulation and normalizing relations with neighboring countries can also be beneficial.
By looking at some of these alternative forms of revenue generation, Pakistan can reduce dependence on foreign debt, and increase it’s trade surplus, thus leaving more room to spend on where it truly matters, education, health, infrastructure development and supporting the local economy instead of relying on imported goods.