TERM PAPER: DEBT CRISIS IN PAKISTAN

COURSE: INTERNATIONAL TRADE & FINANCE

SUBMITTED BY: KANZA REHMAN

SUBMITTED TO: SIR AHMER

Introduction

While Europe happens to be a successful model of rejuvenating development through foreign aid, the
experience of developing countries has been totally different. It would not be an exaggeration to state
that most of the benefits from aid flow out of the recipient country to the donor country. This is on
account of the tied nature of aid, necessitating the use of the donor country’s companies, consultants,
etc. As a result most of the aid money is recycled back to the donor country.

Moreover, conditionalities have had an adverse impact on developing countries. Groll of Action Aid
UK (The Reality of Aid Report 2008) states that conditionalties deny recipients and governments the
right to freely choose policies best suited to their economic and social conditions. Ahmed Swapan
Mahmud of the Voices for Interactive Choice and Empowerment (VOICE) (The Reality of Aid
2008) states that “-------- conditionality hampers the development of the countries they are supposed
to help and infringe on the country’s democracy and sovereignty.” He goes on to state that
conditionalties attached to loans or grants often have negative impacts on the poor countries. “They
impose inappropriate policies, generate transaction costs and stop or start financing according to
donors whims.” Similar ideas have been expressed by other participants to the Reality of Aid Report
2008.

Two important yardsticks for evaluation of aid are democratic ownership and transparency. “---
ownership implies not only participation, but quality participation, with transparency, accountability,
democratic values, and rights at the heart of governance.” Democratic
Ownership is one of the five partnership commitments of the Paris Declaration. Groll points out that
true democratic ownership does not mean ownership by recipient governments. It must involve the
parliament, civil society, women rights groups and other stake holders.
Debt Crisis

How the debt crisis came about

The debt crisis came about with the adoption of a market based monetary policy by the Government
of Pakistan (GOP) in 1990-1991. This was on account of a World Bank (WB)-IMF conditionality
that the GOP borrows at the market rate of interest rather than at a concessional rate from the
commercial banks and the domestic financial institutions. This inflated the size of the domestic debt,
and the offer by the international financial institutions to make credit available at concessional rates
gave birth to the debt crisis. Ever since then, the size of foreign debt (see Table 1) has been on the
rise. A large part of this debt benefited the ruling elite and was transferred abroad to buy property and
assets in western countries.

Debt/GDP Ratio

Total debt as a percentage of the GDP has risen rapidly during 1994-95 to 1998-99, and was almost
as large as the GDP in the latter year. In 1999-2000 the size of debt exceeded the size of the GDP.
From then onwards Debt/GDP started declining, the decline continued throughout the decade, except
for a sudden reversal in 2008.

Foreign debt as a percentage of total debt rose continuously throughout the 1990s. But from the year
2000 it started declining (except for the increase in the year 2001 as an after math of 9/11). But the
increase in foreign debt as a percentage of GDP in 2009 is quite disturbing.

Debt Break down

The terms on which Pakistan obtained debt can be viewed from the breakdown of debt into loans and
grants. These data for the period 1960 to 2007-8 is presented in Table 2. It is interesting to note that
during the 1960s when Pakistan was closely aligned with the West the great bulk of the debt was on
account of grants. The share of grants in the total rose to more than 67% in 1961-62. From then
onwards it started declining and was at an all time low at about 11% in 1969-70. Though it picked up
later, its level during the 1970s was much lower as compared with the 1960s. And in 1978-9 of total
lending to the country only 3.4 percent were on account of grants. The share of grants in the total
gained its 1960s level in the 1980s on account of Pakistan’s alignment with the West during the first
Afghan War. But the cessation of hostilities at the end of the decade led to decline in the share of
grants in the total. This decline continued throughout the 1990s falling to all time low at 3.5% in
1996-97. But with the advent of 9/11 the share of grant in the total started rising and peaked at 46%
in 2005-6, declining thereafter.

The other element of terms on which Pakistan obtained aid is the interest on loans. These data by
bilateral and multi-lateral sources have been presented in the Appendix.
Debt Servicing

Debt servicing on account of the principal and interest has been increasing at a spectacular rate
throughout the period under review. This at a time when the country was faced with a recession as a
result of IMF imposed tight monetary policy has given rise to serious crises in the country. Notice the
tremendous increase from 1994 to 2002, followed by a decline during 2003 to 2005, followed by a
sudden upsurge again during 2006-08 (Table 1). Almost 60% of the tax revenues were used for debt
servicing in 1994-95, rising to a little less than 90 percent by 1999. Debt servicing exceeded total
taxes collected in the country in the year 2000, rising to 123% by 2002, but maintaining a steady
decline for the next six years. But from 2007 it has started increasing again, a trend that was
maintained in 2008. Debt servicing as a percentage of total expenditures started increasing from
about 36% in 1994-5 to about 73% in 2001, declining thereafter.

Debt Servicing, GDP and Exports

A very large amount of revenues are being used for debt servicing as can be seen from Table 3. Even
during the 1960s when a very large percentage of borrowings were on account of grants, debt
servicing rose to more than half of our export earnings in 1969-70. Debt servicing as a percentage of
export earnings remained high during the 1970s and the 1980s as well, although at a slightly lower
level as compared to the 1960s. Even during the 1990s debt servicing was almost as large as one
quarter of our export earnings. Debt servicing as a percentage of GDP was below 2 percent
throughout the 1960s. It was highest in 1968-69 and 1969-70 at 1.8%. It crossed the 2% barrier
during the 1970s and stood at 2.5% of the GDP in 1979-80. Debt servicing as a percentage of the
GDP
increased further during the 1980s and was at an all time high at 3.3% in 1986-87. Debt as a
percentage of the GDP climbed further during the debt crisis of the 1990s and was above 3 percent
for most of the years during this decade. It peaked to 3.8% of the GDP in 1997-98, but declined to its
1960s level as an after math of 9/11.
Pakistan’s Major Donors

Break down of Pakistan’s debt by source for the year 1996-97 are presented in Tables 4.5,6,7 and Figures 2,3,4
and 5 and for the year 2008-09 in Tables 8, 9,10 and 11 and presented in Figures 6,7,8 and 9.

Consortium Countries

In 1996-97 Pakistan’s single largest bilateral donor was Japan, followed by U.S. A., Germany and France
(Table 4 and Figure 2). While Japan continued to be the largest bilateral donor to Pakistan in 2008-09, its share
in total bilateral debt has increased sharply (Table 8 and Figure 6). Of total bilateral aid to Pakistan in 2008-9
almost half has been contributed by Japan. While USA and France have swapped their positions between
themselves for the second and fourth positions. In 1996-97 USA was the second largest bilateral donor and
France the fourth largest bilateral donor. In 2008-09 USA is the fourth largest bilateral donor, and its second
position has been taken by France. Germany continues to be the third largest bilateral donor in 2008-09 as
well.

Non-Consortium Countries

Among the non –consortium countries China is the single largest donor contributing almost three fourths of the
total in 1996-97 (Table 5 and Figure 3), followed by Saudi Arabia, USSR, Kuwait, Abu Dhabi, etc. China
continued to contribute three quarters of non-consortium loans in 2008-09 as seen in Table 9 and Figure 7.
This was followed by Saudi Arabia, United Arab Emirates and Kuwait respectively. While USSR was the third
largest non-consortium contributor in 1996, its successor Russia is not a contributor in 2008-09.

Multi- lateral Donors

Among the multi lateral donors the Asian Development Bank happened to be the single largest contributor in
1996-97, followed by the IDA and the World Bank as shown in Table 8 and Figure 4. But in 2008-09 World
Bank has emerged as the largest single donor contributing almost half of total multi lateral aid to Pakistan in
that year (Table 10 and Figure 8). This was followed by the ADB and the IDA, IFAD and IDB. While the
contribution of Nordic countries is minimal.

Bilateral versus Multilateral Donors

Multi lateral and bilateral aid accounted for almost half of the total aid in 1996-97 as shown in Table 7 and
Figure 5. The share of multi lateral sources increased to three quarters in 2008-09, with the consortium
countries contributing almost one quarter with non –consortium countries contributing a miniscule amount as
shown in Table 11 and Figure 9.
Socio-Economic-Political Impact of Debt in Pakistan

The debt crisis is giving rise to severe crises in the economy. The development crisis owes its
existence to the meager amounts allocated for development during the period under review as
revealed by Table 12. Notice the particularly dismal amounts spent on development during the
1990s. But development expenditures started increasing from 2000 onwards, and continued to
increase throughout the decade, except for a minor decline in FY 2003. In a scenario of an extreme
short fall of physical and social infrastructure, the development crisis is reflected in the form of
scarcity of water, power, road network, telecommunication, education and health facilities.

The non-availability of resources for investment is giving rise to serious recessionary tendencies as is
apparent from Table 13 and may be termed as a growth crisis. We find that the rate of growth of the
economy was quite impressive during the 1980s (apart from occasional down turns for the
agriculture sector which is subject to the vagaries of weather). But the rate of growth of GDP and that
of individual sectors has declined throughout the 1990s. The declines in 1992-93, 96-97 and 98–99
are quite disturbing. The policies have given rise to the most serious growth crisis Pakistan has ever
faced. This is reflected by a stagnating economy, de-industrialization, unemployment, declining real
wages, increase in poverty, etc. But the rate of growth of GDP, manufacturing and service sectors
improved during the period 2002-3 to 2006-7 as debt/GDP, debt servicing/tax revenues, debt
servicing/total revenues, debt servicing/total expenditures declined as seen in Table 1.

The growth and development crises have thus given effect to a distributional crisis. The rich are
getting richer and the poor getting poorer. According to an ADB estimate, of the total population
living in the cities 50 % were living below the poverty line, whereas in rural Sindh the percentage
rose to 85. This is giving rise to social conflict, i.e. conflicts between different segments of the
population and between different segments of the population and the government. There has been an
increase in crime rates, robberies, suicides and murders. Governments are perceived as following
policies which are not in the best national interest. This is in turn giving rise to political polarization
and instability in the country. It has resulted in downfalls of governments as default on debt appeared
imminent. This is a political crisis, which owes its existence to the debt crisis.

In-spite of the serious crises afflicting the socio economic and political fabric of Pakistan, no attempt
has been made at managing these. They have worsened over the years making the country un-
governable. Since there is a cause and effect relationship between the various crises, it is important to
concentrate on the root cause of these crises and then work through to the rest of them.
 A CRONICAL OF CRISIS

Debt Crisis

Political Crisis Development

Social Crisis Growth crisis

Distributional
Crisis
Recommendations and Conclusion

In this section we summarize the main findings of the study and give policy recommendations.

 The debt crisis came about with the adoption of a market based monetary policy by the
Government of Pakistan (GOP) in 1990-1991. This was on account of a World Bank (WB)-IMF
conditionality that the GOP borrow at the market rate of interest rather than at a concessional rate
from the commercial banks and the domestic financial institutions. A large 24 part of this debt
benefited the ruling elite and was transferred abroad to buy property and assets in western
countries.

 Total debt as a percentage of the GDP has risen rapidly during 1994-95 to 1998-99, and was
almost as large as the GDP in the latter year. In 1999-2000 debt exceeded the size of the GDP. From
then onwards Debt/GDP started declining, the decline continued throughout the decade, except for
a sudden reversal in 2008.

 Foreign debt as a percentage of total debt rose continuously throughout the 1990s. But
from the year 2000 it started declining (except for an increase in the year 2001 as an after
math of 9/11).But the increase in foreign debt as a percentage of GDP in 2009 is quite
disturbing.

 During the 1960s when Pakistan was closely aligned with the West, the great bulk of the
debt was on account of grants. The share of grants in the total gained its 1960s level in the 1980s on
account of Pakistan’s alignment with the West during the first Afghan War. But the cessation of
hostilities at the end of the decade led to decline in the share of grants in the total. This decline
continued throughout the 1990s, falling to all time low at 3.5 % in 1996-97. But with the advent of
9/11 the share of grant in the total started rising and peaked at 46% in 2005-6, declining thereafter.

 Debt servicing on account of the principal and interest has been increasing at a spectacular
rate throughout the period under review. Almost 60% of the tax revenues were used for debt
servicing in 1994-95, rising to a little less than 90 percent by 1999. Debt servicing exceeded total
taxes collected in the country in the year 2000, rising to 123 % by 2002, but maintaining a steady
decline for the next six years. But from 2007 it has started increasing again, a trend that was
maintained in 2008. Debt servicing as a percentage of total expenditures increased from about 36 %
in 1994-5 to about 73 % in 2001, declining thereafter. Debt servicing as a percentage of export
earnings remained high during the 1970s and 1980s as well, although at a slightly lower level as
compared to the 1960s. Even during the 1990s debt servicing was almost as large as one quarter of our
export earnings.

 Debt servicing as a percentage of GDP was below 2 percent throughout the 1960s. It was
highest in 1968-69 and 1969-70 at 1.8 %. It crossed the 2 % barrier during the 1970s and stood at
2.5 % of the GDP in 1979-80. Debt servicing as a percentage of the GDP increased further during the
1980s and was at an all time high at 3.3 % in 1986-87. It climbed further during the debt crisis of the
1990s and was above 3 percent for most of the years during the decade of the 1990s. It peaked to
3.8 % of the GDP in 1997-98, but declined to its 1960s level as an after math of 9/11.

In 1996-97 Pakistan’s single largest bilateral donor was Japan, followed by U.S. A., Germany and
France. While Japan continued to be the largest bilateral donor to Pakistan in 2008-09, its share in
total bilateral debt has also increased sharply.

USA is the fourth largest bilateral donor in 2008-09, and its second position has been taken by
France. Germany continues to be the third largest bilateral donor in 2008-09 as well.

China continued to contribute three quarters of non-consortium loans in 2008-09 . This was
followed by Saudi Arabia, United Arab Emirates and Kuwait respectively.

World Bank has emerged as the largest single donor contributing almost half of total multi
lateral aid to Pakistan in that year. This was followed by the ADB and the IDA, IFAD and
IDB.

Multi lateral and bilateral aid accounted for almost half of total aid in 1996-97. The share of
multi lateral sources increased to three quarters in 2008-09.

The debt crisis in Pakistan has given rise to the development crisis due to the meager
amountsallocated for development during the period under review. The policies have given rise to
themost serious growth crisis Pakistan has ever faced. This is reflected by a stagnating economy,de-
industrialization, unemployment, declining real wages, increase in poverty, etc. Thegrowth and
development crises have thus given effect to a distributional crisis. The rich aregetting richer and the
poor are getting poorer. This is giving rise to social conflict, i.e.conflicts between different segments
of the population and between different segments of thepopulation and the government. There has
been an increase in crime rates, robberies, suicidesand murders. Governments are perceived as
following policies which are not in the bestnational interest. This is in turn giving rise to political
polarization and instability in thecountry.

During the 1990s when the debt crisis hit Pakistan, consumer, wholesale, food, non food and
sensitive price indices were high. By the end of the decade price increases were at much lower rates.
But with increased borrowing from the international financial institutions all the indices started rising
again. While the food price and the sensitive price indices started rising from 2006-07, all the indices
rose sharply during the period 2007-08. Since the data do not go beyond 2007-08, the real escalation
in prices in 2009 are not discernible.

As a result of increase in prices generally and food prices more specifically, average real wage across
different sectors has not been able to maintain the increasing trend during the 1999-2000 – 2003-
04 period. In fact, the decline during 2003-04 to 2005-06 is rather steep. Although there appears to
be some recovery in 2006-07. Since the data beyond this year are not available, the decline in real
wages as a result of food price escalation during 2008-09 has not been adequately captured in our
study. When data for these two years becomes available, the decline in real wages as a result of
price escalation will be found to be more pronounced.
In-spite of the serious crises afflicting the socio economic and political structure of Pakistan,
no attempt has been made at managing these. Since there is a cause and effect relationship between
the various crises, it is important to concentrate on the root cause of these crises and then work
through to the rest of them.

An evaluation of different debt management strategies, and the severity of the crises afflicting the
state of Pakistan, it is imperative that the country’s debts be written off. It is only through removing
the debt burden that we can address the very serious crises discussed in the Report, which have
become worse with the passage of time.
References

 http://www.statpak.gov.pk/depts/index.html
 http://en.wikipedia.org/wiki/Economy_of_Pakistan
 http://www.finance.gov.pk
 http://www.sbp.org.pk/reports/annual/arFY09/Vol2/Chapter-9.pdf
 http://www.scribd.com/doc/29241000/Challenges-to-Pakistan-Economy
 Wizarat, Shahida (2000 b), Debt Crisis and its Management, Dawn, 20 August.