Interest charges, devaluation of the rupee, financing of the primary deficit drive up public debt

ISLAMABAD: The Ministry of Finance said that interest charges, currency devaluation and primary deficit financing due to the economic slowdown linked to Covid-19 are the main reasons for the massive increase in public debt, according to a statement released Thursday by the Ministry of Finance. .

To fully understand the underlying economic realities, it is necessary to analyze the sources of the increase in total public debt over the past three years.

Interest charges: The preference for short-term domestic borrowing in the absence of adequate liquidity reserves resulted in a short-term profile of domestic debt at the end of fiscal 2018. This short-term profile resulted in interest charges. high on debt, as interest rates had to be raised significantly to curb rising inflationary pressures.

The government paid 7.5 trillion rupees in interest service, which accounts for 50% of the increase in total public debt.

Impact of currency devaluation: The exchange value of the rupee has been kept at an artificially high level in the past, which triggered the balance of payments crisis. The transition to the market-based exchange rate regime, being an inevitable policy choice, resulted in a sharp depreciation of the exchange rate resulting in high inflation, high interest rates, slower GDP growth and a decline. tax revenue related to imports.

This exchange rate depreciation added about Rs.29 trillion (20% of the increase) to government debt. This increase is not due to the borrowing but to the revaluation of the external debt in rupees after the devaluation of the currency, he said.

Financing of the primary deficit: The impact of the economic slowdown due to the Covid-19 pandemic has mainly resulted in higher than expected primary deficits. A total of 3.5 trillion rupees (23% of the increase) has been borrowed to finance the primary deficit.

Cash management and others: A sum of Rs1 trillion (7% of the increase) was due to the increase in government cash balances to meet emergency needs, as well as the difference in face value, which is used for recording the debt and the amount realized. value, which is recorded as the budgetary revenue of government bonds issued during this period.

The government took the revolutionary and economically sound step of not borrowing from the State Bank of Pakistan (SBP) and the maintenance of a cash buffer, which led to a one-time increase in debt. However, this increase in debt was offset by a corresponding increase in the government’s liquid cash balances.

A better way to measure the level of debt is to use the debt-to-GDP ratio instead of looking at the absolute values ​​of debt. In this way, it is important to point out that Pakistan experienced one of the smallest increases in its debt-to-GDP ratio during the pandemic.

The global debt-to-GDP ratio increased by 13 percentage points, while Pakistan’s debt-to-GDP ratio saw a minimal increase of 1.7 percentage points in 2019-2020.

Pakistan’s debt-to-GDP ratio actually fell by 4 percentage points, indicating a lower debt burden at the end of June 2021 compared to the previous year.

To conclude, the increase in debt over the past three years has occurred mainly in the 2018/19 fiscal year due to the implementation of difficult and unavoidable policy choices. If the market-based exchange rate, a sustainable level of the current account deficit, adequate liquidity reserves and a long-term domestic borrowing profile had been maintained, the debt burden would have been further reduced through the efforts. fiscal consolidation supported by aggressive spending controls and growth in tax and non-tax revenues.

Since most of the major fiscal and monetary policy adjustments have been made, the debt burden is expected to decline sharply over the next few years.

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