Immpact of Government Debt On Economic Growth-Project Report

INSTITUTE OF BUSINESS AND TECHNOLOGY
Impact of Government Debt on Economic

Growth of Pakistan
Submitted by
Danish Herchand Jacob (BME / 1200)
Wajahat Khan (BME / 1203)
Syed Manzar Hussain (BME / 1130)
Course Code :
MS-699
In partial fulfillment of the requirement for

the degree
MS (Business Administration)
FACULTY OF MANAGEMENT SCIENCES
FALL- 2012
Impact of Government Debt on Economic Growth of Pakistan
CONTENTS
Page No.
ACKNOWLEDGMENT
DECLARATION .
ABSTRACT .....
LIST OF ACRONYMS
LIST OF GRAPHS ....
01
02
03
04
05
CHAPTER NO. 1 INTRODUCTION

1.1
1.2
1.3
1.4
Introduction.
Purpose of Study...
Research Objectives.
Research Methodology.
07
10
10
10
CHAPTER NO. 2 LITERATURE REVIEW

2.1
Literature Review................................ 12
CHAPTER NO. 3 GOVERNMENT DEBT

3.1
3.2
3.3
3.4
Introduction....
Types of Debts..
Sources of Government Borrowing...
Instruments of Debt .
17
20
26
28
CHAPTER NO. 4 IMPACT OF BORROWING FROM CENTRAL

BANK
4.1
4.2
4.3
4.4
4.5
4.6
4.7
Inflation......
Interest Rate..
Crowding Out....
Currency
Budget Deficit
Government Expenditure
GDP
32
33
34
35
36
37
37
CHAPTER NO. 5 IMPACT OF BORROWING FROM

COMMERCIAL BANKS
5.1
Budget Deficit .... 42

Institute of Business & Technology
5.2
5.3
5.4
5.5
5.6
Interest Rate...
Inflation...
Crowding Out
Private Investment ......................................................
Unemployment .
44
44
44
45
46
CHAPTER NO. 6 CONCLUSION AND RECOMMENDATIONS

6.1
Conclusion.. 48
6.2
Recommendations.... 49
REFERENCES..... 51
ACKNOWLEDGEMENT
All praises and thanks to Allah Almighty by whose powers and glory all good
things are accomplished. He is also the most merciful who bestowed upon us the
potential, ability and an opportunity to work on this project.
It is a matter of great pleasure to express our cordial gratitude to our esteemed

project supervisor Dr. Noor Ahmed Memon for his wise and painstaking
guidance that he has so generously given us throughout this project work. We
would also like to thank our evaluator Dr. Noor Ahmed Memon again for
assigning this interesting project and providing the opportunity to learn and gain
most valuable experience from this exercise.
Last but not the least; we are extremely grateful to all our colleagues who equally
encouraged us in our project.
Regards,
_____________________________________________________
Danish Herchand Jacob
Wajahat Khan
Syed Manzar Hussain
DECLARATION
This dissertation is submitted in the Institute for Business and
Technology for the degree of MBA (Management Science).
We, hereby, declare that no portion of the work referred to in
this dissertation has been submitted in support of any
application for another degree or qualification of this university or
any other institution of learning.
Signatures:
Names:
Wajahat Khan
Syed Manzar Hussain
Date:
INSTITUTE OF BUSINESS AND

TECHNOLOGY
ABSTRACT SUBMITTED BY:

Wajahat Khan
Syed Manzar Hussain
DISCIPLINE:
MBA (Banking & Finance)
TITLE OF PROJECT REPORT:
Impact of Government Debt on

Economic Growth of Pakistan.
MONTH OF SUBMISSION:
FALL- 2012
NAME OF PROJECT SUPERVISOR: Dr. Noor Ahmed Memon

Abstract
This project is about impact of government debt on economic growth of Pakistan.

Pakistan is surrounded by serious socio-economic problems. Due to low tax base
and deficits, Pakistan has to rely on both external and internal capital flows. The
foreign capital flows are not easily accessible but domestic capital flows are
approachable at all times. Government debt is an important means of bridging
government financing gaps, but should be used in a moderate level because it
will increase liabilities in future. In Pakistan outstanding government debt has
exceeded the GDP and thus income per capita is lower than per citizen
indebtedness. This all is due to mismanagement and poor planning sector in the
nation. It appears that external financing of domestic budget deficit is cheaper
than the domestic financing. However, under certain circumstances external
financing is significantly more expensive than the domestic financing. Both types
of debt have negative role in the real per capita income growth rate, so they
should be avoided or their quantity should be reduced in future. Debts should be

used only for needed purposes and should keep away from corrupt people while
debt for IMF should be avoided because their conditions worsen the economy of
debtor nation.
Keywords: Government debt, Domestic debt, External debt, economic growth,
central bank, commercial banks.
LIST OF ACRONYMS
SBP
State Bank of Pakistan
BoP
Balance of Payments
CDNS
Central Directorate of National Savings
DSC
Defence Savings Certificates
DPCO
Debt Policy Coordination Office
EDL
External Debt and Liabilities
FRDL
Act Fiscal Responsibility and Debt Limitation Act
GDP
Gross Domestic Product
IMF
International Monetary Fund
LTD
Long-term Debt
MRTB
Market Related Treasury Bills
MTB
Market Treasury Bill
NSS
National Saving Schemes
PIB
Pakistan Investment Bonds
PKR
Pakistani Rupee
SDR
Special Drawing Rights
STD
Short-term Debt
TPD
Total Public Debt
USD
United States Dollar
LIST OF GRAPHS
1.
Public Debt as percent of GDP ........................... 18
2.
Public Debt by country as percent of GDP ......... 19
3.
Trends in Permanent, Floating & Unfunded Debt ........................ 23
4.
External Public Debt as percent of GDP ............................... 24
5.
Sources of Public Debt percent .......................... 27
6.
Budgetary Borrowing from Scheduled Banks .......................... 28
7.
CPI Inflation .................................. 33
8.
Loans to Private Sector Business ................... 46
CHAPTER NO.1 - INTRODUCTION

1.1
Introduction.
07
1.2
Purpose of Study...
10
1.3
Research Objectives.
10
1.4
Research Methodology.
10
CHAPTER NO.1 - INTRODUCTION

1.1
Introduction
Government debt means the central government borrowing to ensure it can

finance all its planned expenditure and curtail its budget deficit. Public debt and
National debt are also called Government debt. Government debt also refers to
the debt of a state or provincial government, and local government. If a
government gets a budget surplus, it should not need any increase in its debt. If
a government gets a budget deficit, it should need more debt and refers to the
difference between government receipts and spending that is the increase of
debt over a particular period.
To finance this deficit, a government will normally borrow money by issuing
government
bonds,
bills,
and
securities.
Local
governments,
specific
departments or agencies may issue their own bonds to finance expenditure.

Rather than issuing currency, the government of a developing country with low
credit ratings may need to negotiate loans from foreign governments and
institutions such as the World Bank, IMF or other international financial
institutions and creditors.
The system of debt credit makes it easy for the state to borrow, and has led to
tremendous increase in the indebtedness of modern states. Government debt is
not the one and only method of financing government operations. Governments
can also issue currency to monetize their debts, thereby removing the need to
pay interest. But this practice simply reduces government interest costs rather
than truly canceling government debt.
The government generates its income from the citizens. Government debt is an
indirect debt of the taxpayers. Government debt can be categorized as internal
debt owed to lenders within the country such as central bank, commercial banks,
and other financial institutions and creditors. External debt is owed to foreign
lenders such as the World Bank, IMF or other international financial institutions
and creditors.
Another term called as Sovereign debt usually refers to government debt that has
been issued in a foreign currency. Another common division of government debt
is by duration of due repayment. Short term debt is generally considered to be for
one year or less e.g. treasury bills payable after three months, advances from the
central bank which are intended to bridge the gap between current revenue and
current expenditure also called floating debt. Long term is for more than ten
years also called funded debt. Medium term debt falls between these two
divisions.
Other terms are Productive and Unproductive debts. The productive debt is
expected to create assets which will yield income sufficient to pay the principal
and interest on the loan. In other words they are expected to pay their way they
are self-liquidating. On the other hand loans raised for war do not create any
asset they are a dead weight and are regarded as unproductive.
Growing government debt is an international trend. It has become a common
issue of the fiscal sectors of most of the economies. Almost all developing
countries governments are under minor or high debt situation. Government debt
is not a major problem rather problem is with the mismanagement and unsustainability of the debt. Debts are only effective if appropriate policies are in
place and can be used to control growing debt.
Pakistans Government debt to GDP was 60.10 percent of the country's Gross
Domestic Product in 2011. Historically, from 1994 until 2011, Pakistans
Government debt To GDP averaged 70.62 percent and reaching an all-time high
of 87.90 percent in December 2001 and reaching a record low of 54.90 percent
in December 2007. Generally, Government debt as a percent of GDP is used by
investors for measuring a countrys ability to make future payments on its debt
which thus affects the countrys borrowing costs and government bond yields.
Since independence Pakistan is facing serious problems in balance of payments
deficit. To finance this deficit in balance of payments, the country adopted to rely
on external debt. In July 1950, Pakistan joined the International Monetary Fund
(IMF) and World Bank. In 2001 Pakistan was ranked as severely indebted
country of South Asia by World Bank. The outstanding government debt of
Pakistan has exceeded its GDP and thus income per capita is lower than per
citizen indebtedness.
In the past whenever there was an emergency usually a war the monarch on his
own personal credit. Book on history abound in instances of fabulous hoards and
accounts of loots and sacks of hoarded wealth either from kings treasuries or
from temples and church. But this method of finance is not suited to modern
conditions. It will be inadequate and uneconomical.
Beside war there are several other causes which have brought about great
increase in the size of public debt. The most important cause of increase in
public debt is war or war-preparedness. Nation attaches a great importance to
their territorial integrity and they consider no sacrifice too much to defend their
country. Every war therefore leaves the country under greater debt.
The increase is also due to fairly frequent budget deficits on current accounts.
The deficits arise from the necessity of maintaining full economic activity in the
economic which may have ceased to expand.
Increase in public debt is also due to the undertaking of welfare schemes by
governments in modern times. In public utilities where there is no convenient
profit check no tight control over costs can be maintained and there are more
losses than gains. They also add weight of public debt.
In recent year urge for economic growth has induced the under-developed
countries to contract debts both internally and externally. The volume of public
debt has consequently swollen.
1.2 Purpose of Study
The main purpose of my study is:
(i)
To find out the impact of government debt on economic growth.
(ii)
To find out the impact of government debt borrowing from central bank.
(iii)
To find out the impact of government debt borrowing from commercial
banks.
1.3 Research Objectives
The basic objectives of this research report are to find out the impact of
government debt on Pakistans economic growth. To find out the impact of
government debt borrowing from central bank and commercial banks and its
direct effect on various variables such as GDP, inflation, interest, crowding out
and other factors.
1.4 Research Methodology
The suggested methodology which can be successfully applied in our
comparative case study. Gathering the previous studies that centers in the
application of the impact of government debt on economic growth of Pakistan are
a great advantage for the study. In the use of the same method the ideas,
knowledge, and skills can be applied.
10
CHAPTER NO.2 - LITERATURE REVIEW

2.1
Literature Review
12
11
CHAPTER NO.2 - LITERATURE REVIEW

2.1 Literature Review
Almost all governments face budget deficit due to high expenditure and fewer
revenues. Governments can get revenue by increasing taxes, printing money,
domestic or external borrowing and using previous budget surplus. When the
government decides to borrow instead of introducing additional tax measures, to
finance the budget deficit, it creates a liability on itself known as public debt.
A government has various alternatives to borrow for the purpose of financing
fiscal deficit. One way is to borrow directly from the central bank which is
equivalent to printing of money. The other alternatives are; borrowing from
domestic commercial banks, borrowing from domestic non-bank sector and
borrowing from external sources. Each method has its own implications for
various aspects of the economy. Government usually adopts a mix strategy and
utilizes a number of options at the same time that have more benefit for the
present situation of the country.
Cristina Checherita and Philipp Rother1 finds evidence for an impact of public
debt on per-capita GDP growth rate across twelve euro area countries over a
long period of time starting in 1970. It shows a concave (inverted U-shape)
relationship between the public debt and the economic growth rate with the debt
turning point at about 90-100% of GDP. The channels through which public debt
is likely to have an impact on economic growth rate seem to be private saving,
public investment, total factor productivity, and sovereign long term nominal and
real interest rates.
Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli2 found that debt
and economic activity in industrial countries leads to conclude that there is a
clear linkage: high debt is bad for growth. When public debt is in a range of 85%
of GDP, further increases in debt may begin to have a significant impact on
1
2
2010, The Impact of High and Growing Government Debt on Economic Growth, European Central Bank.
2011, The Real Effects of Debt, Federal Reserve Bank of Kansas City.
12
growth: specifically, a further 10 percentage point increase reduces trend growth

by more than one tenth of 1 percentage point. For corporate debt, the threshold
is slightly lower, closer to 90%, and the impact is roughly half as big. Meanwhile
for household debt, best guess is that there is a threshold at something like 85%
of GDP, but the estimate of the impact is extremely imprecise.
A clear implication of their results is that the debt problems facing advanced
economies are even worse than we thought. Given the benefits that governments
have promised to their populations, ageing will sharply raise public debt to much
higher levels in the next few decades. At the same time, ageing may reduce
future growth and may also raise interest rates, further undermining debt
sustainability. So, as public debt rises and populations age, growth will fall. As
growth falls, debt rises even more, reinforcing the downward impact on an
already low growth rate. The only possible conclusion is that advanced countries
with high debt must act quickly and decisively to address their looming fiscal
problems. The longer they wait, the bigger the negative impact will be on growth,
and the harder it will be to adjust.
Martin Melecky3 referred debt management objectives in his work, The main
objective of public debt management is to ensure that the
governments
financing needs and its payment obligations are met at the lowest possible cost
over the medium to long run, consistent with a prudent degree of risk. see IMF
and WB (2001).
Martin Melecky3 analyzed survey data on public debt management strategies
across income groups, regions and levels of indebtedness using graphical tools.
Regression analysis was carried out to explain the graphical analysis and
condition on more economic indicators possibly relevant for public debt
management. More specially, the graphical and regression analyses were
focused on explaining how the incidence of (i) public debt management
strategies, (ii) the published strategies and (iii) strategic benchmarks varies
3
2007, A Cross-Country Analysis of Public Debt Management Strategies, The World Bank, Banking
& Debt Management Dept.
13
across income groups, regions, levels of indebtedness and other economic

characteristics.
He found that a higher level of income in a country appears to increase its
probability of having a debt management strategy. The level of indebtedness
seems to be also positively correlated with the incidence of a strategy where the
graphical analysis indicated that the relationship could be non-linear. The latter
would imply that as a country becomes more indebted it aims at increasing the
quality of debt management, however, after reaching high levels of indebtedness
it gives up on debt management and possibly engages in debt renegotiations and
focuses on debt sustainability issues. Across the World Banks regions, Europe
and Central Asia appears to stand out in regards to the incidence of strategies.
Concerning other factors, the degree of debt concessionality appears to
significantly decrease the probability of having a strategy, and so does the
volatility of external shocks.
C. Emre Alper and Lorenzo Forni4 reassessed the impact of rising government
debt ratios on long-term real rates using real time expected fiscal and
macroeconomic variables for a large sample of AEs and EMEs over the period
2002-10.They specifically addressed whether emerging economies are exposed
to increases in funding costs due to high and rising AEs debt. Main findings are
the following:
Results support previous findings of a positive effect of domestic debt on
domestic long-term real yields. Long-term real interest rates rise by about 2.5 to
4 basis points for a one percentage point increase in one-year-ahead expected
debt-to-GDP ratio in EMEs (past a threshold for the debt ratio of about 50
percent). On the other hand, for AEs our estimates support a linear effect with
impact ranging between 2.5 and 7 basis points.
EMEs are exposed to increases in funding costs due to high and rising AEs
debt. Past a threshold of about 70-80 percent of GDP, a one percent of GDP
4
2011, Public Debt in Advanced Economies and its Spillover Effects on Long-term Yields, IMF.
14
increase in expected AEs debt-to-GDP ratio (and in particular the U.S. debt) has
a significant impact (about 10 basis points evaluated at the 2010 debt ratio
levels) on EMEs yields. They also show that the U.S. debt ratio has a broadly
similar impact on the real yields of others AEs.
The interest rate channel is an important element in explaining the spillover effect
from AEs debt. They show that AEs real rates, and in particular U.S. long-term
real rates, have spillover effects on other countries real yields, including EMEs.
Douglas W. Elmendorf and N. Gregory Mankiw5 touched on some of the major
issues in the debates over the effects of Government debt. Because of the broad
scope of this topic, they have had to be selective.
An important economic issue facing policymakers during the last two decades of
the twentieth century has been the effects of government debt. The reason is a
simple one: The debt of the U.S. federal government rose from 26 percent of
GDP in 1980 to 50 percent of GDP in1997. Many European countries exhibited a
similar pattern during this period. In the past, such large increases in government
debt occurred only during wars or depressions. Recently, however, policymakers
have had no ready excuse. This episode raises a classic question: How does
government debt affect the economy? That is the question that they take up in
his paper.
1998, Government Debt, Harvard University and NBER.

15
CHAPTER NO.3 - GOVERNMENT DEBT

3.1
Introduction ..
17
3.2
Types of Debt .
20
3.3
Sources of Government Borrowing .
26
3.4
Instruments of Debt
28
16
CHAPTER NO.3 GOVERNMENT DEBT

3.1
Introduction
Accumulation in debt stock has been the prime problem faced by both
developing and developed countries. Developing countries face this problem
more often as they need to borrow to facilitate their development process and
accelerate the pace of growth. However, the borrowed funds required to be
allocated properly for the productive expenditures and in accordance to their
repayment ability. Though debt is useful for the growth of the economy however
dependence on debt must be closely monitored and proper strategy should be
adopted for enhancing the repayment capability of the country. High and
unsustainable levels of debt have serious repercussions for the economy in
terms of heavy debt servicing and decreased developmental expenditures,
essential to carry on the growth process. Besides, availability of lesser funds for
investing in the economy and increase in taxes for repayment, hampers growth
as it limits the productive investment, resulting in shrinking of the debt repayment
capacity of the economy. It creates crowding out effect as well as has negative
impact on the foreign and domestic investment and development plans of the
government.
The fiscal and real sectors of the economy are strongly linked to internal and
external debt through certain economic variables. On one hand, it appears that
the budget deficit is the major cause of domestic debt. While, on the other hand,
it turns out that the deficiency in savings and its effects on the balance of
payments is the basis of foreign debt. Notwithstanding the rationale behind the
occurrence of debt, the level and rate of growth of public debt should not unduly
limit the countrys monetary, fiscal and exchange rate flexibility. A sound debt
management strategy ensures that ample financing is provided for development
and growth objectives to be met. While a debt policy can guarantee the
sustainability of a countrys stock of debt, the need for these debt flows is
eventually determined by fiscal and monetary stance along with developments on
the external account. Conversely, the absence of prudent debt management will
17
have serious consequences to effective monetary management as well as fiscal

operations and will place an additional burden on the external account in the
shape of a greater amount of resources being diverted to debt servicing. In
essence, debt policy is a dynamic financing policy that has to react to
implementation of various public policies and act as a constraint to public policy
over ambitions.
For quite a few years, most of the countries of the world have made appropriate
steps in order to manage and strategize their public debt. Proper debt
sustainability analysis is conducted to keep the debt levels under check. It is
important to note that any attempt to control the debt stock, or the public sector
deficit, too tightly may induce instability in other macroeconomic variables. There
is a trade-off between ensuring intergenerational equity through fiscal
responsibility and the goal of short term macroeconomic stabilization. In recent
past majority of the countries around the world have seen worsening of fiscal
accounts and the consequent erosion in debt sustainability indicators as the
aftermath of international debt and credit crisis of 2007-08.
Pakistans debt dynamics has undergone substantial changes. Higher fiscal

deficit led to accumulation of huge debt both in absolute and relative terms. Due
to non-availability of sufficient funds from the external sources, the financing
18
focus shifted towards domestic sources that led to shortening of maturity profile
of public debt. A confluence of unfavorable factors including lower GDP growth,
devastating floods, severe energy shortages, hemorrhaging Public Sector
Entities (PSEs), high inflation, weak security situation and global economic
recession resulted in higher fiscal deficits in the recent past.
Financial discipline over a prolonged period is essential for maintaining
macroeconomic stability in the economy. There is a general consensus that a
persistent commitment to financial discipline can be achieved by following rulebased fiscal policy. Pakistans government formed and incorporated a rule-based
fiscal policy with the Fiscal Responsibility and Debt Limitation (FRDL) Act 2005,
and was passed by the Parliament in June 2005. This Act ensures responsible
and accountable fiscal management by all governments, the present and the
future and also encourages informed public debate about fiscal policy.
In the country review, Sri Lanka is leading with more debt with Pakistan and India
on second and third positions.
19
3.2
Types of Debt
Domestic Debt:
Domestic debt is widely perceived as being an endogenous rather than an
exogenous policy choice variable and hence, a countrys issuance capacity in
this regard is determined by the level of income, pool of savings and institutional
quality. Moreover, the budget deficit can be covered directly through money
creation by the central bank or by increased credit of the banking system.
Excessive monetary financing translates into excess overall demand and
inflation. Compared to borrowing from the central bank, market-based domestic
borrowing adds more to macroeconomic stability, low inflation and reduced
exposure to external real and domestic monetary shocks, domestic savings
generation and private investment. Hence, governments by and large, opt for a
market-based domestic borrowing strategy in order to develop domestic financial
markets.
On the downside, though, a broad expansion in domestic debt poses significant
negative connotations for private investment, fiscal sustainability and ultimately
economic growth and poverty reduction in case of thin financial markets and poor
debt management capacity. Additionally, given access to cheap external finance,
in the form of concessionary loans and grants from international financial
institutions, governments preferably avoid seemingly expensive domestic
borrowing. Nonetheless, liquid domestic debt markets can help strengthen
money and debt capital markets, boost private savings, and stimulate
investment. Domestic debt consists of three main types: permanent debt, floating
debt, and unfunded debt.
This imbalance in the term structure of domestic debt needs to be addressed as
undue reliance on short-term sources of financing raises the rollover or
refinancing risk for the government. Failure to issue new debt in order to mature
a large amount of outstanding short term debt may trigger a liquidity or debt
20
rollover crisis. The increase in frequency of such operations (due to their short
term nature) coupled with any adverse rise in interest rates may leave the
government vulnerable to high cost of debt.
Domestic Debt Types:
Permanent Debt
Permanent debt includes instruments for medium to long-term debt such as
Pakistan Investment Bonds (PIBs). The share of permanent debt in total
domestic debt is continuously declining since 2004-05 owing to irregular and thin
issuance at the longer end of the sovereign yield curve. This declining trend was
reversed in FY2011 with the debt management strategy to lengthen the maturity
profile of domestic debt. Contribution of permanent debt to total domestic debt
stock increased to 19 percent in FY2011 from 17 percent in FY2010. The
outstanding stock of permanent debt grew by 41 percent over last fiscal year,
registering a net addition of Rs 327.6 billion in 2010-11. Sizeable receipts from
Government Ijara Sukuk bond and Pakistan Investment Bonds contributed to this
expansion. Government mopped up net of retirement Rs 182.4 billion through
successful auctions of Ijara Sukuk bond and Rs. 112.3 billion through Pakistan
Investment Bonds during fiscal year 2011. Prize bonds observed a rise of 17
percent in its stock during the period under review. A dearth of private sector
credit demand during 2010-11 and banks preference of risk-free sovereign credit
in view of mushrooming non-performing loans augured well for the government
securities market and overwhelming participation was witnessed in their auctions.
Notably, the coupon rates on PIBs were increased in line with market
expectations.
Floating Debt
The short-term borrowing needs of the government are catered by floating debt
which includes Treasury Bills. The share of floating debt to total domestic
increased to 54 percent in FY2011 from 52 percent in last fiscal year. Floating
21
debt recorded an enlargement of 35 percent during 2010-11 compared to 26

percent in the previous fiscal year. Keeping in view the negative consequences
of monetization of the fiscal deficit, the government has adhered strictly to the
net zero quarterly borrowing limits from the SBP and retired Rs 32 billion during
the fiscal year. The outstanding stock of Treasury bills through auction increased
by 43 percent in 2010-11, as commercial banks interest in government paper
revived. This preference for T bills was an outcome of a number of factors
including increase in risk aversion, low demand for credit from the private sector
and the market expectation of reduction in policy rate.
Unfunded Debt
Unfunded debt is made up of the various instruments available under the
National Savings Scheme (NSS) which is an on-tap source of financing. The
share of unfunded debt in total domestic debt increased by 3 percentage points,
due to heavy reliance on government to borrow in floating debt to meet the fiscal
deficit and payment of Rs. 120 billion against past years unpaid power tariff
differential subsidy through floating treasury bills. During 2010-11, major NSS
instruments witnessed considerable expansion except Defense Savings
Certificates and Savings Accounts. The stock of unfunded debt stood at Rs
1,655.8 billion as of June 30, 2011 recording a healthy growth of 14 percent.
Bahbood Savings Certificates and Special Savings Certificates Accounts topped
the list with a net investment of Rs 61.7 billion and Rs. 58.2 billion respectively
during 2010-11. During the course of the year 2010-11, the rate of return on
these instruments has been linked with the yield on long term government paper
such as PIBs. Moreover, price setting is being done on a quarterly basis. It is
important to note that funds raised through National Saving Schemes (NSS)
contribute 28 percent of the total domestic debt down 10 percentage points from
FY2006. Central Directorate of National Savings (CDNS) is a major source for
Government to mobilizing domestic retail savings. Government need to
strengthen the capacity building of CDNS with a view to restructured and
converted CDNS into vibrant customer centric distribution channel for
22
government debt instruments. Transfer pricing mechanism may be introduced to

induce efficiency.
The rates offered on various NSS are aligned with the government bonds (PIBs),
however the time lag involved in resetting profit rates is a major source of interest
rate arbitrage. The rate setting should be dynamic and more closely aligned to
the domestic market yield curve. Furthermore, the put option embedded in most
of the NSS is a potential source of severe liquidity crises. The Government
should immediately stop this practice and create instrument liquidity by
developing secondary market for NSS instruments to ensure long term liquidity to
the government. A pre-requisite in this regard, however, is a complete
automation of CDNS operations.
External Debt and Liabilities

The countrys External Debt and Liabilities (EDL) stock was recorded at US$
60.1 billion as of June 30, 2011. During 2010-11, US$ 4.5 billion was added to
the stock resulting in a growth of 8.1 percent. Bulk of this increase was
contributed by depreciation of US Dollar against other major international
currencies. A surplus current account led by strong export growth primarily
because of higher cotton prices in the international markets, low debt and nonInstitute of Business & Technology
23
debt creating foreign were responsible for this muted growth of EDL adjusted for
currency movement. There was no fresh disbursement under IMF-SBA during
the period under review whereas other heads underwent minor changes. As a
percentage of GDP in dollar terms, the EDL was down by 290 bps in 2010-11
compared to 2009-10 and approximated to 28.5 percent.
External Debt and Liabilities Types:

Public and Publically Guaranteed Debt
Public and Publically Guaranteed (PPG) debt was US$ 46.6 billion at end-June
2011, up by US$ 3.4 billion against FY2009-10. This lower growth of 7.8 percent
has restrained the overall increase in the stock of EDL nonetheless, the PPG
debt still accounts for a major portion of EDL amounting to 77.4 percent for 201011, up by 0.4 percentage points in comparison to 2009-10. Bulk of this increase
is contributed by exchange rate movement and not by fresh disbursements.
There has been a repayment of USD 75 million and USD 100 million of
commercial loans and NBP/Bank of China deposits respectively. USD 185 million
worth of short term debt guaranteed by Islamic Development Bank was repaid.
The stock of publically guaranteed debt decreased by 11 percent and rested at
USD 105 million at the end of FY2010-11, as compared to USD 118 million last
24
year. This has mainly emanated because no new commercial loan was raised
and other bilateral were repaid.
Private Non-Guaranteed Debt
The outstanding stock of private non-guaranteed debt increased by only US$ 315
million at the end the fiscal year 2010-11 at US$ 3.483 million. Slower economic
activity, prolonged power outages and deteriorating security situation has held
back the corporate sector to embark upon any fresh investment and hence,
shrinkage in financing needs to be met through external sources was apparent in
the form of diminishing private sector debt.
IMF Debt
Pakistan entered in to Stand by Arrangement with IMF in 2008; during the fiscal
year under review no fresh disbursements were made rather repaid US $ 267
million to IMF.
Foreign Exchange Liabilities
Foreign Exchange Liabilities (FEL) mainly comprise of central bank deposits and
foreign currency bonds. FEL decreased by 9.1 percent in FY2010-11 and
summed to US$ 1.0 billion at end-June 2011.
Currency Movements and Translational Impact
Foreign loans and other debt obligations of the Government of Pakistan are
contracted in various currencies. The bulk of these loans (approximately 93
percent) are in three major international currencies. For reporting purposes, the
outstanding balance of these loans is converted into US Dollar. Hence,
movement in the US Dollar vs. third currency exchange rates has a significant
impact on Pakistans outstanding stock of external debt. Depreciation of the
dollar will cause an increase in the outstanding stock, while appreciation will
cause a decrease. During the course of 2010-11, currency movements caused
an increase of approximately US$ 3.3 billion in Pakistans outstanding EDL. On
25
the contrary, first quarter of the current fiscal year registered a decrease of US$
44.7 million in EDL owing to currency movements.
External Debt Servicing
During FY2010-11, external debt servicing summed to US$ 4,799 million that is
14.3 percent lower than the previous year. A segregation of this aggregate
number shows a payment of US$ 2,348 million in respect of maturing EDL stock
while interest payments were US$ 963 million. US$ 1,488 million was rolled-over.
Among the principal repayments, US$ 980 million of multilateral debt and US$
325 million of Islamic Development Bank accounted for most of the share.
Similarly, hefty interest payments worth of US$ 963 million on foreign currency
public debt contributed to the bottom line. In FY2010-11, the central bank
deposits were mostly rolled-over. During July-September 2011, the servicing on
external debt was recorded at US$ 1.356 billion. Out of the grand total, principal
repayments were US$ 475 million and interest payments were 181 million. The
rollovers amounted to US$ 700 million in the first quarter of 2011-12. Over the
last
three
years,
the
debt
servicing
levels
have
notably
increased.
Notwithstanding, with the IMF-SBA repayments set to initiate in the second half
of FY 2011-12, the servicing will increase to much higher levels.
3.3
Sources of Government Borrowing
Prudent fiscal management helps mobilize national savings, motivates efficient

resource allocation and facilitates sustainable economic growth. Pakistan has
historically had large fiscal deficits, with the growth in expenditures outpacing
revenues. The highest ever fiscal deficit was 12.2 percent of GDP in FY67,
following the war with India in 1965, whereas the highest decade-wise average
was 11.6 percent of GDP in the 1980s. One of the primary reasons attributed to
the historically weak fiscal performance is that revenue growth has not kept pace
with economic growth. Revenue generation has been historically sluggish. Taxes
are a crucial component of the countrys revenue structure forming a big share.
26
The constant need for borrowing to finance the budget deficit has resulted in a
progressive deterioration of the countrys debt position. Pakistans total debt and
liability stock (TDL) has surged largely driven by the persistently large fiscal
deficits.
While financing through the banking system has traditionally been the primary
source of funding the budget deficit, it has gained further importance and growth
recently. In addition, non-bank borrowing has also become a popular avenue for
seeking domestic financing. Within non-bank sources, financing through National
Saving Schemes and short term Treasury Bills is more popular.
Borrowing from the Banking System

Notably, there are three types of government borrowings from the banking
system:
(1) Borrowings for budgetary support (from the central bank and the commercial
banks).
(2) Provincial government borrowings from the central bank in the form of Ways
and Means Advances to tide temporary imbalances in receipts and
payments.
27
(3) Provincial and federal government borrowings for financing quasi-fiscal deficit
i.e. commodity operations, borrowings by public sector enterprises (PSEs)
and autonomous bodies, and subsidies extended to various governmentsponsored special credit schemes.
3.4
Instruments of Debt
Pakistan Investment Bonds (PIBs)

Pakistan Investment Bonds (PIBs) are the long term bonds issued by the
Government of Pakistan and sold through the State Bank of Pakistan via periodic
auctions. PIBs are issued with tenors of 3, 5, 7, 10, 15, 20 and 30 Years. PIBs
give a low risk long term investment option as backed by the Government of
Pakistan. PIBs offer a fixed semi-annual coupon and repayment of principal
option at maturity. They are highly liquid SLR eligible securities that are actively
traded in the secondary market. The minimum denomination of PIBs is
Rs.100,000.
Government Ijara Sukuk Bond
Government of Pakistan Ijara Sukuk Bond is a conventional fixed coupon bond
issued by the Government of Pakistan. The price of bond is based on market
determined yields. Sukuk Bond is issued with tenor of 3 years and semi-annual
rentals. The minimum denomination is Rs. 100,000. Sukuk Bond is not
28
redeemable before maturity. Sukuk Bond is script less & traded freely in the
Secondary Market and is transferable.
Prize Bonds
Prize Bonds Scheme is offered by Government of Pakistan. These Bonds are
available in the denominations of Rs.200, Rs.750, Rs.1, 500, Rs.7, 500, Rs.15,
000, Rs.25000 and Rs.40,000. These bonds are issued in series. Each series
consist of one less than 1,000,000 bonds. No fixed return is paid but prize draws
are held on quarterly basis. The draws are held under common draw method and
the numbers of prizes are same for each series.
Treasury Bills (T-Bills)
Treasury bills (T-Bills) are zero coupon instruments issued by the Government of
Pakistan and sold through the State Bank of Pakistan via fortnightly auctions. TBills are issued with maturities of 3 months, 6 months and 1 Year and are priced
at a discount. T-Bills are risk free. T-Bills are SLR eligible securities that are
actively traded in the secondary market and are therefore highly liquid. They are
issued with a minimum denomination of Rs.100, 000.
National Savings Schemes (NSS)
National Savings Schemes (NSS) are offered by Government of Pakistan which
includes various Defense Savings Certificates such as; Defense Savings (DSC),
Special Savings (SSCR), Regular Income (RIC), and Behbood Savings (BSC).
This also includes various Savings Accounts such as; Savings (SA), Special
Savings (SSA), and Pensioners Benefit (PBA). Prize Bonds are also offered in
these schemes which have been discussed above.
29
CHAPTER NO.4 - IMPACT OF BORROWING FROM CENTRAL BANK

4.1
Inflation .
32
4.2
Interest Rate
33
4.3
Crowding Out ..
34
4.4
Currency .
35
4.5
Budget Deficit .
36
4.6
Government Expenditure .
37
4.7
GDP .
37
30
CHAPTER NO.4 - IMPACT OF BORROWING FROM CENTRAL

BANK
Government borrowing limits the primary central bank function of maintaining
price stability. Since borrowing is essentially akin to printing of new money, it
erodes purchasing power of the local currency in the form of high and persistent
inflation and exchange rate depreciation. These problems become more acute
when the rise in domestic assets, led by government borrowings from SBP,
significantly outpaces growth in foreign assets. Moreover, unscheduled
government borrowing from SBP also complicates liquidity management,
undermining the credibility of monetary policy.
The inflation-growth trade-off depends on the level of inflation, a low level of
inflation may prove to be beneficial and stimulate growth, but at higher levels it is
harmful for growth. The harmful effect of inflation on growth is driven by the
volatility in inflation. An increase in real GDP growth is followed by a subsequent
drop in inflation. It is important to note that the increase in real GDP growth has
been in consonance with a drop in budget deficit. However, deficit volatility has
increased over time, with the budget deficit to GDP ratio being highly volatile in
the current decade. Impact of fiscal deficit on inflation seems mixed, however in
case of developing countries; the influence is strong, transmitted either through
monetary expansion or more directly, through adding on to aggregate demand.
Budget deficits as a percentage of GDP seem to closely follow each other
especially with the increasing reliance on SBP for financing the deficit.
Besides its inflationary tendencies, borrowing from the central bank also
complicates liquidity management by injecting liquidity in the system through
increased currency in circulation. This automatic creation of money complicates
the monetary policy transmission mechanism. Furthermore, ease of access to
potentially unlimited borrowings from the central bank does not bode well for the
governments incentive mechanism to address and resolve structural issues on
the fiscal front.
31
Government borrowing also creates complications for liquidity management by

causing volatility in short-term interest rates. The inability to accurately forecast
all government flows on any given day creates difficulties in maintaining
adequate liquidity in the interbank market, which results in excessive volatility in
the overnight repo rates. In addition to changes in government deposits and
deviations from T-bill auction targets, seasonal swings of liquidity due to banks
lending for commodity financing further enhances the uncertainties in liquidity
projections, which then permeate to the retail market rates. The movement in
interest rates, therefore, is not in accordance with the direction of the prevalent
monetary policy stance. The impacting factors are described below:
4.1
Inflation
Government debt (the amount of money a government owes) can be tied to

inflation. A growing government debt is an indication that governments will try to
monetize debt and will inflate their way out of debt. However, financial analysts
argue that governments cannot effectively inflate their way out of debt. Moreover,
financial analysts believe that inflation is not a concern unless the economy is
booming.
A government may default on its debt if it cannot pay its debt or refuses to pay.
When the government defaults on its debt, the currency is no longer considered
valuable on the currency market. The end result of government debt when it is
defaulted is usually very high inflation because the currencys value drops
dramatically. This can cause hyperinflation.
Inflation is measured in Pakistan by the consumer price index. This index is
effectively a collection of goods which attempts to represent a cross section of
the total goods in the market. If the overall price of goods is rising, we are said to
be in a period of inflation. If the overall price of goods is falling, we are said to be
in period of deflation.
32
Whatever the connection, government debt is generally considered to be

undesirable, and so is inflation. Inflation is particularly undesirable for debtors
who get paid back in money that is worth less than the money they lent.
Controlling government debt and inflation are two ways a government can keep
its private sector strong.
Pakistans average CPI inflation for FY12 was 11 percent, which was well within
the target of 12 percent for the year and on the lower side of SBPs earlier
projections. The main reason for this moderation in inflation is a collapse in real
private investment, indicating a structurally weak economy. However, it continues
to persist in double digits for the fifth consecutive year. This persistence is
primarily due to entrenched expectations of inflation remaining high. It seems that
key drivers for this expectation are continued fiscal borrowings from the SBP
despite legal restrictions and feared depreciation of exchange rate even with a
modest external current account deficit.
4.2
Interest Rate
Increase in inflation will also bring an increase in the interest rate. When the
government borrows money to pay expenses, the money it receives is not free.
The interest on the debt will be paid from future tax receipts. Both a large debt
33
and a high interest rate on any debt will generate high debt service payments to
pay the interest. In both cases, the high debt payments will necessitate cuts in
the provision of services. To pay interest on the debt, especially if spending does
not decrease, taxes must be raised to generate more income for the government.
When the government has less money to spend, it cuts back on services. When
taxes are increased, consumers have less money to spend because the
government takes more of it. Thus one of the effects of government debt is less
money to be spent in the future, either by the government or by individuals.
Pakistans short term market interest rates remained volatile and on average on
the higher side, imparting inertia to other market interest rates. As a result, the
decline in lending rates for the private sector, after a 200 basis point reduction in
the policy rate in H1-FY12, has been less than desirable.
The long term interest rates, on the other hand, increased in July 2012. As a
consequence, the spread between 10-year PIB rate and 6-month T-bill rate
increased to 121 bps.
4.3
Crowding Out
Crowding Out effect occurs when increase in public sector spending replaces or
drives down the spending in private sector. Crowding out refers to when
government must finance its spending with taxes and/or with deficit spending,
leaving businesses with less money and effectively "crowding them out." One
explanation of why crowding out occurs is government financing of projects with
deficit spending through the use of borrowed money. Because the government
borrows such large amounts of capital, its activities can increase interest rates.
Higher interest rates discourage individuals and businesses from borrowing
money, which reduces their spending and investment activities.
Because a government can tax its citizens to pay back its debts, it may be seen
as more creditworthy than private borrowers. The government can also offer
exemptions from income taxes on interest on its own debt, making its debt more
34
attractive to buyers and investors. By making its debt more attractive as an

investment as the debt obligation grows the government crowds out private
borrowers from the credit marketplace. This results in private borrowers having to
pay a higher interest rate to borrow than they would if the government wasn't
competing for limited lender's funds.
Pakistans fiscal borrowings from the scheduled banks grew by 50 percent in
FY12 and contributed 67 percent to the overall increase of 14.1 percent. Apart
from crowding out the private sector, these substantial and, at times,
unpredictable fiscal borrowings created substantial challenges for monetary
management. State Bank of Pakistan (SBP) has also warned that government
borrowing is crowding out the private sector from access to credit.
4.4
Currency
The currency in circulation increases due to increasing Government debt. A

country is said to monetize debt when it inflates it way out of debt. Basically,
under a fiat money system, where money is not backed by assets such as silver
or gold, the government has the power to devalue its own currency by printing
more money. This in effect allows them to back debts with devalued currency.
When the government must sell bonds on its debt and has few buyers, it may
choose to buy its own debt back. When the federal government sells bonds to
raise money and the bonds are bought by the Treasury, this is called
monetization. This results in generating money to pay current debt, raising the
money supply. In a recession or depression, monetization inflates money supply
when the money supply is decreasing. Thus the monetization prevents worse
deflation. In a period of inflation, monetization worsens inflation by adding to a
growing money supply. In all cases, monetization is the equivalent of printing
money and thus it decreases the value of the currency.
35
4.5
Budget Deficit
Budget deficit increases due to increasing Government debt. Pakistans

Government Budget deficit reached to 6.60 percent of the country's Gross
Domestic Product in 2011. Historically, from 1990 until 2011, Pakistan
Government Budget averaged 4.29 Percent of GDP reaching an all-time high of
8.80 Percent of GDP in December of 1990 and a record low of -6.60 Percent of
GDP in December of 2011. Government Budget is an itemized accounting of the
payments received by government (taxes and other fees) and the payments
made by government (purchases and transfer payments). A budget deficit occurs
when a government spends more money than it takes in.
Pakistans budget deficit has increased to Rs 1,761 billion (8.5 per cent of the
GDP) during the last financial year 2011-12 against the revised target of 6.6 per
cent of the GDP due to the shortfall in revenue collection and additional
governments expenditures and borrowings. However adding Rs 391 billion (1.9
per cent of the GDP) one off payment on account of debt consolidation, the
budget deficit reached to 8.5 per cent of the GDP against the revised target of
6.6 per cent during the fiscal year ended on June 30 2012. The government
earlier fixed fiscal deficit target at four per cent of the GDP at time of budget
2011-12, which was later revised to 4.7 per cent. However, later, it was once
again revised to 5.5 per cent of the GDP. The government failed to achieve the
revenue collection target, did not receive external resources and its expenditures
and borrowings increased resulting in higher deficit. The countrys total
expenditures stood at Rs3,936 billion or 19.1 per cent of the GDP against the
countrys revenue collection of Rs 2,566 billion or 12.4 per cent of the GDP thus
leaving fiscal/budget deficit at Rs 1,370 billion or 6.6 per cent of the GDP in the
previous financial year 2011-12. According to the figures, the break-up of
revenue collection of Rs 2,566 billion revealed that government has collected Rs
2,053 billion as tax revenue and Rs 514 billion as non-tax revenue in the period.
36
4.6
Government Expenditure
Pakistans government failed to achieve the revenue collection target and did not
receive external resources and its expenditures increased resulting in higher
deficit. The countrys total expenditures stood at Rs3,936 billion or 19.1 per cent
of the GDP against the countrys revenue collection of Rs 2,566 billion or 12.4
per cent of the GDP thus leaving fiscal/budget deficit at Rs 1,370 billion or 6.6
per cent of the GDP in the previous financial year 2011-12. The official figures
further revealed that total expenditures stood at Rs 3,866 billion. The expenditure
on interest payment has recorded at Rs889 billion in the last financial year 201112, defence expenditure increased to Rs 507 billion, the non-defence, noninterest expenditures increased to Rs823 billion in FY 2012. The expenditures on
subsidies have recorded to Rs167 billion in the last fiscal year. The development
expenditures increased to Rs317 billion in FY 2012. The provincial current
expenditures have been recorded at Rs981 billion in 2011-12. The provinces
overspent Rs28 billion, or 0.6 percent of GDP, incurring a net deficit of 0.2
percent. The expenditures of provinces on development jumped to Rs375 in FY
2012.
4.7
Gross Domestic Product (GDP)
The Gross Domestic Product (GDP) in Pakistan was worth 211.09 billion US
dollars in 2011. The GDP value of Pakistan is roughly equivalent to 0.34 percent
of the world economy. Historically, from 1960 until 2011, Pakistan GDP averaged
48.82 Billion USD reaching an all-time high of 211.09 Billion USD in December of
2011 and a record low of 3.71 Billion USD in December of 1960. The gross
domestic product (GDP) measures of national income and output for a given
country's economy. The gross domestic product (GDP) is equal to the total
expenditures for all final goods and services produced within the country in a
stipulated period of time.
Pakistan recorded a Government debt to GDP of 60.10 percent of the country's
Gross Domestic Product in 2011. Historically, from 1994 until 2011, Pakistan
37
Government Debt to GDP averaged 70.62 Percent reaching an all-time high of

87.90 Percent in December of 2001 and a record low of 54.90 Percent in
December of 2007. Generally, Government debt as a percent of GDP is used by
investors to measure a country ability to make future payments on its debt, thus
affecting the country borrowing costs and government bond yields. This page
includes a chart with historical data for Pakistan Government Debt to GDP.
Pakistans huge debt and liabilities reached Rs12.1 trillion in fiscal year 2011. As
a result of this huge debt, public debt service (principal and interest payments)
also consumed 43.7 per cent of the government revenue in the fiscal year 2011.
In 2008, the public debt was just Rs6.055 trillion which doubled in the past four
years. At the same time, the Government debt to government revenue ratio is
also alarming, which is well above the level in the fiscal year 2007 before the
onset of the economic downturn.
The Government debt to revenue ratio has reached 474 per cent. At the same
time, it was reported that Pakistan Government debt to GDP ratio in the past four
years is hovering around 60 per cent. Also, the Fiscal Responsibility and Debt
Limitation Act of 2005 could not achieve the core objective of the law. Neither
revenue deficit could be eliminated from economy, nor could the government
debt be kept within prudent levels. Due to lack of serious measures in terms of
governance, the economy is on the path of a downward spiral.
Borrowing purposes, goals, strategies and mandatory reporting requirements of
government debt management in Pakistan must be legally defined, and
government should follow best internal practices of definition of government debt.
Pakistan with over Rs12 trillion of government debt did not have a well functional,
professional and dedicated debt management office for looking after effective
public debt management. Appropriate debt management office must be created.
38
CHAPTER NO.5 - IMPACT OF BORROWING FROM COMMERCIAL BANKS

5.1
Budget Deficit ..
42
5.2
Interest Rate
44
5.3
Inflation ....
44
5.4
Crowding Out .
44
5.5
Private Investment .
45
5.6
Unemployment ..
46
39
CHAPTER NO.5 - IMPACT OF BORROWING FROM

COMMERCIAL BANKS
Besides borrowing from the central bank, the government also has a heavy
reliance on borrowing from commercial banks to meet its budgetary
requirements.
These borrowings are in the form of:
(1)
Selling Treasury Bills (T-Bills), Pakistan Investment Bonds (PIBs) and Ijara
Sukuk through the auction system.
(2)
Acquiring bank loans for financing commodity operations.
(3)
Borrowings by PSEs and other autonomous bodies.
Each of these forms of borrowings is assessed in this section, along with their
associated implications. Before the introduction of Treasury bill auctions in March
1991, the government used to borrow from commercial banks through the tap
system by selling 3-month T-Bills at administered rates. Borrowing on tap
enabled the government to manage liquidity (through this tap) by either selling
T-bills, or by injecting money in the market by redeeming already sold bills
through discounting. It is generally agreed that the use of tap sales is linked to
governments cash management capabilities; if these capabilities are limited, tap
sales are a source of timely access to funds. However, the tap system fails to
establish a pricing mechanism based upon the supply of funds in the market and
their demand thereof by the government. Since banks are generally forced to
lend at a fixed rate offered by the government, it further impedes efficient credit
pricing for the private sector.
Therefore, the auction system is considered to be a superior alternate to the tap
arrangement with the onset of financial liberalization and associated reforms, the
sale of public debt on tap was replaced with the auction system in March 1991.
For this purpose, government introduced two debt instruments, Government of
Pakistan Market Treasury Bills of 6-months maturity and Federal Investment
40
Bonds (FIBs) of 1, 3, 5 and 10 years maturity. FY92 was the first full year of
government borrowing through the auction system, with the government raising
Rs. 76 billion through 6-month T-Bills and Rs. 45 billion through FIBs.22 In the
interest of boosting the corporate debt market and to introduce longer tenor
securities, the government decided to launch Pakistan Investment Bonds (PIBs)
in December 2000. Assessing the characteristic features of the T-bills auction
system used by the central bank reveals that the SBP follows the Multiple
Price/Sealed Bid auction mechanism.
For the implementation of the auction system, a system of Approved Dealers
was set in place. Approved Dealers had to ensure a wide distribution of
government securities and work for the development of a secondary market.
However this system was reformed in 2000 wherein the concept of Primary
Dealers was introduced and this continues to date. Presently, T-bill auctions are
carried out on a fortnightly basis, conducted every alternate Wednesdays with
settlement the next day. Primary Dealers submit sealed tender applications on
Tuesday and Wednesday which are opened in public on Wednesday and then a
cut-off rate is decided for each tenor. During the period from 1995 to 2009, the
cut-off rate was decided by SBP. However, to separate functions of debt and
monetary management, the responsibility of deciding cut-off rates was
transferred to the Ministry of Finance (MoF) with effect from January 2009.
Depending upon governments borrowing needs and the maturity profile of
previous issues, the MoF had started making public announcements of quarterly
targets for T-Bills and semi-annual targets for PIBs, from November 2008. In
addition to meeting the governments financing needs; T-bill auctions have the
embedded objective of developing the secondary market for government debt
securities. Banks participation in T-Bill auctions has increased considerably
since FY09. With quarterly limits on the increase in NDA under the IMF-SBA
since November 2008, governments recourse to central bank borrowing
generally remained within stipulated limits and it diverted its funding needs
41
towards scheduled banks. Banks on the other hand had already started to show
signs of credit restraint given the increase in the stocks of NPLs since end-CY08,
and investing in government securities helped them in consolidating their risk
profile shows banks willingness to invest in T-bills as indicated by the increased
net (quarterly) amount offered in FY10. On the other hand, the amount accepted
also showed a rise in Q4-FY10. Net accepted amount in T-Bills auctions was Rs
335.6 billion in FY10 relative to Rs 186.4 billion for FY09, with a rise of Rs 149.3
billion. The higher quantum of borrowing by the government through auctions is
due to both delayed and lower than anticipated realization of external inflows,
and rising fiscal spending along with low tax receipts during the year.
Notably, banks are generally likely to divert their pool of loanable funds to
investments in government securities if they offer a higher rate of return,
irrespective of risk considerations from higher NPLs. The spread between the
return on loans disbursed to the private sector and the T-bill rate shows a
declining trend which has served as an incentive for banks to invest more heavily
in risk-free government securities, rather than lend to the private sector, to the
extent that demand for credit exists.
Not only are banks loanable funds tied up in financing governments budgetary
borrowings, they are also used for financing commodity operations and public
sector enterprises. The impacting factors are described below:
5.1
Budget Deficit
Government borrowing from commercial banks for the budgetary support has
more than doubled during July 1 to October 19 as compared to the same period
last year, according to the latest statistics of the State Bank of Pakistan on
Friday.
42
The government has borrowed Rs561 billion as of October 19. In comparison,

the borrowing of the government in the corresponding period last year stood at
Rs185 billion, showing an increase of Rs376 billion.
The government has been heavily borrowing from commercial banks to finance
its rising budget deficit. The fiscal deficit is expected to rise between eight and
8.5 percent of GDP by the end of this fiscal year, amid expected record public
spending by the government on account of general elections next year. Given the
situation of persistent fiscal deficit, there seems to be no letup in the government
borrowing from the banking sources this year.
There have been massive shortfalls in tax and non-tax revenues in the wake of
decline in the Federal Board of Revenues (FBR) tax collection and nonmaterialization of the budgeted external financial inflows. Moreover, due to
frequent retirement of the SBP loans by the government, the entire deficit burden
has been shifted on domestic banks. The SBP data showed that loans retirement
was made possible by substantial borrowings from the scheduled banks, which
increased to Rs564 billion during July-October FY13 from Rs198 billion a year
ago.
The fiscal borrowing from the banking system soared to Rs306 billion, while the
government has also retired a loan of Rs257 billion to the State Bank during the
period under review according to the data. The drying up of external financing for
the fiscal deficit left the government with no other option but to borrow from
domestic sources, especially from the banking system. In addition, the
government also relied heavily on commercial banks, which reduced the flow of
loan-able funds for the private sector. The excessive bank borrowing has
resulted in wiping out of the liquidity from the banking system. Consequently, the
State Bank is persistently injecting liquidity into the banking system to
counterbalance the effects of huge government borrowing from the commercial
banks. Meanwhile, the central bank on Friday injected Rs520 billion worth of
liquidity in the banking system through an open market operation.
43
5.2
Interest Rate
As already discussed above in the impacting factors of government borrowing

from central bank, increase in inflation will also bring an increase in the interest
rate if government borrows from commercial banks.
5.3
Inflation
As already discussed above in the impacting factors of government borrowing

from central bank, increase in the interest rate will also bring an increase in the
inflation if government borrows from commercial banks.
5.4
Crowding Out
The borrowing of government from the commercial banks is rising significantly to

meet its swelling expenses and thus providing less room for the economic
managers to ease the monetary stance to provide stimulus to the private sector
of the country, which is facing stringent business environment amid several
hurdles. The broad money supply in the country grew by 5.3 percent from the
July 2011 to date, where money supply continues to remain tilted towards
domestic liquidity.
The previous fiscal year remained sound for the Pakistan economy
comparatively as the money supply was in much more control and external
account pressure was not as firm as it is currently in an absolute terms. The
major victim of this governments rising expenditure financing remains the private
sector as crowding out effect is resisting them to grow as the financing options
are not easily available for them. The commercial banks also prefer to shift their
advances to cash strapped government to yield risk free return which is attractive
amid high policy rate stance.
Under the present circumstances, the government borrowing now occupies 61
percent of total domestic money supply as borrowing from the SBP lately crossed
Rs 189 billion. The circular debt issue is also getting frightening as the days
44
progress and governments intension to resolve it by issuing TFC could ruin the
private sector further as the countrys budget deficit has risen to 4.5 percent or
Rs 932 billion in the first half of the financial year.
Moreover, the persistent depreciation of Pakistan currency, slow exports growth,
rising oil prices, weak foreign inflow could further aggravate the liquidity
shortages being faced by the government. Persistent government borrowings will
certainly put pressure on interest rates in the long run. Hence, it is imperative that
government now should look to improve tax collection and increase tax base to
solve budget deficit problem.
5.5
Private Investment
High government borrowing can cause crowding out. This means private sector
investment is reduced because the private sector are lending to the government
instead of investing in more profitable private projects. Economy seems to have
no indication of positive growth as main engine for growth, the private sector, has
been retiring bank debt instead of borrowing to accelerate activities.
According to the report, the private sectors net retirement rose to Rs92 billion. It
was even worse than last years net retirement of Rs62 billion which resulted in
growth much below the target. However, banks half yearly result showed that
profit was up by 20 per cent compared to six months of previous year. Most of
the income was earned by lending to the government. Nothing changed during
the first quarter of the current fiscal year as banks continued to invest in
government papers while the private sector remained out of debt market.
Bankers said the private sector borrowing would rise in second quarter of this
fiscal year as sector requires huge amount to continue their machines operating.
The private sector, especially textile sector, requires huge working capital to buy
cotton, yarn and other related raw and semi raw material. During the previous
year, private sector borrowing for working capital increased substantially high,
but no project financing was noted.
45
5.6
Unemployment
Unemployment is also caused due to government borrowing from commercial

banks and due to crowing out affect and non-investment in private sectors there
are less jobs and growing unemployment trend.
46
CHAPTER NO.6 - CONCLUSION AND RECOMMENDATION

6.1
Conclusion ...
6.2
Recommendations .. 49
48
47
CHAPTER NO.6 CONCLUSION AND RECOMMENDATION

6.1
Conclusion
Recent levels of high government debt and large external debt are results of
persistent fiscal and current account deficits, non-optimal utilization of financial
resources, diminishing debt carrying capacity and rising cost of borrowing.
Unfortunately, government has not installed any system to quantify and manage
the fiscal impact of these debts; rather these debts are created essentially on an
ad hoc basis and without regard to fiscal consequences.
Soundness of Pakistans debt position remains higher than the internationally
accepted thresholds. Total Government debt levels around 3.5 times and debt
servicing below 30 percent of government revenue are generally believed to be
within the bounds of sustainability. Total government debt in terms of revenues
has increased to 4.7 times during 2010-11, as opposed to 4.3 times in the
previous fiscal year whereas the debt serving to revenue has declined to 37.7
percent in 2010-11 from 40.4 percent in 2009-10. Regardless, the widening gap
between the real growth of revenues and real growth of Total Government Debt
needs to be aggressively addressed to reduce the debt burden and improve the
debt carrying capacity of the country to finance the growth and development
needs.
Pakistans external debt and debt servicing in terms of foreign exchange
earnings stood at 1.3 times and 11.4 percent during 2010-11 compared to 1.5
times and 16.5 percent respectively in 2009-10, within the acceptable threshold
of 2 times and debt servicing below 20 percent of foreign exchange earnings.
However, repayment of IMF debt starting from 2HFY2012 will put pressure on
external debt servicing in coming years, therefore it is imperative for the
government to take measures for attracting both debt and non-debt foreign
currency flows.
48
Divergent trends between growth in foreign exchange earnings and government

revenues on one hand, and foreign exchange payments and expenditure on the
other hand, point towards underlying structural issues which need to be
addressed. Export receipts and other foreign currency non-debt creating flows
need to be increased above and beyond the growth of foreign exchange
payments and growth of external debt and liabilities. By doing so, the
government will be able to restrict the non-interest current account deficit, and
ensure the sustainability of present levels of external debt.
The difference between revenues and expenditure and their growth rate poses
similar problems for public debt management. To limit the growth of public debt
burden and to avoid future debt traps, it is essential that significant real growth in
revenues is achieved while undertaking a simultaneous rationalization of
expenditure. Debt reduction to sustainable levels cannot be achieved without
persistent economic growth. The slowdown in growth is a major consequence of
rising debt burden and simultaneously adversely impacts the debt servicing
capacity of the economy. Therefore it is important for the government to adopt an
integrated approach for economic revival and debt reduction strategy, which will
require some difficult trade-offs in the short-term, thus implementing structural
reforms that boost potential growth is a key to ensure debt sustainability.
6.2
Recommendations
Government must take appropriate policies especially on the expenditure side to

help controlling of growing government debt as high debt levels directly or
indirectly harms economic growth. Governments of developing economies have
in general a limited number of options to reduce their public debt. On the one
hand they can adjust fiscal policies by running sufficient primary budget
surpluses to lower their debt. On the other hand they can create an environment
conducive to growth through the implementation of sound macroeconomic and
structural policies in order to grow their way out" of indebtedness.
49
Major debt reductions are mainly driven by decisive and lasting (rather than timid
and short-lived) fiscal consolidation efforts focused on reducing government
expenditure, in particular, cuts in social benefits and public wage spending.
Second, robust real GDP growth also increases the likelihood of a major debt
reduction because it helps countries to grow their way out" of indebtedness.
High debt servicing costs exert a disciplinary effect via market forces and require
governments to set up credible plans to stop and reverse the increase in debt
ratios.
Drastic and permanent fiscal consolidation mainly concentrating on the
expenditure side seems more appropriate than tax increases and timid
adjustments. With the appropriate fiscal policies, country can foster economic
growth and restore fiscal sustainability.
50
REFERENCES
1.
Alper, Emre and Forni, Lorenzo (2011), Public Debt in Advanced

Economies and its Spillover Effects on Long-term Yields, IMF Report.
2.
Cecchetti, Stephen G, Mohanty, M S and Zampolli, Fabrizio (2011), The

Real Effects of Debt, Federal Reserve Bank of Kansas City Paper.
3.
Checherita, Cristina and Rother, Philipp (2010), The Impact of High and
Growing Government Debt on Economic Growth, European Central
Bank Paper.
4.
Elmendorf, Douglas W. and Mankiw, N. Gregory (1998), Government

Debt, Harvard University and NBER Report.
5.
Melecky, Martin (2007), A Cross-Country Analysis of Public Debt

Management Strategies, The World Bank, Banking & Debt Management
Dept Paper.
6.
Nickel, C, P Rother, and L Zimmermann (2010), Major Public Debt

Reductions: Lessons from the Past, Lessons for the Future, ECB
Working Paper.
7.
Qureshi, A Masroor, (2011), Pakistan Debt Policy Statement 2011-12,

Debt Policy Coordination Office Ministry of Finance.
8.
Pakistan Ministry of Finance 2012, Pakistan Economic Survey

2011-12, Economic Advisers Wing, Finance Division, Government
of Pakistan, Islamabad.
51

Immpact of Government Debt On Economic Growth-Project Report

Încărcat de

Informații document

Titlu original

Drepturi de autor

Formate disponibile

Partajați acest document

Partajați sau inserați document

Opțiuni de partajare

Vi se pare util acest document?

Este necorespunzător acest conținut?

Drepturi de autor:

Formate disponibile

Immpact of Government Debt On Economic Growth-Project Report

Încărcat de

Drepturi de autor:

Formate disponibile

INSTITUTE OF BUSINESS AND TECHNOLOGY

Impact of Government Debt on Economic

In partial fulfillment of the requirement for

Impact of Government Debt on Economic Growth of Pakistan

CHAPTER NO. 1 INTRODUCTION

CHAPTER NO. 2 LITERATURE REVIEW

CHAPTER NO. 3 GOVERNMENT DEBT

CHAPTER NO. 4 IMPACT OF BORROWING FROM CENTRAL

CHAPTER NO. 5 IMPACT OF BORROWING FROM

Budget Deficit .... 42

Impact of Government Debt on Economic Growth of Pakistan

CHAPTER NO. 6 CONCLUSION AND RECOMMENDATIONS

Institute of Business & Technology

It is a matter of great pleasure to express our cordial gratitude to our esteemed

INSTITUTE OF BUSINESS AND

Danish Herchand Jacob

MBA (Banking & Finance)

TITLE OF PROJECT REPORT:

Impact of Government Debt on

NAME OF PROJECT SUPERVISOR: Dr. Noor Ahmed Memon

This project is about impact of government debt on economic growth of Pakistan.

should be avoided or their quantity should be reduced in future. Debts should be

Impact of Government Debt on Economic Growth of Pakistan

State Bank of Pakistan

Central Directorate of National Savings

Defence Savings Certificates

Debt Policy Coordination Office

External Debt and Liabilities

Act Fiscal Responsibility and Debt Limitation Act

Gross Domestic Product

International Monetary Fund

Market Related Treasury Bills

Market Treasury Bill

National Saving Schemes

Pakistan Investment Bonds

Special Drawing Rights

Total Public Debt

United States Dollar

Institute of Business & Technology

Impact of Government Debt on Economic Growth of Pakistan

Public Debt as percent of GDP ........................... 18

Public Debt by country as percent of GDP ......... 19

Trends in Permanent, Floating & Unfunded Debt ........................ 23

External Public Debt as percent of GDP ............................... 24

Sources of Public Debt percent .......................... 27

Budgetary Borrowing from Scheduled Banks .......................... 28

CPI Inflation .................................. 33

Loans to Private Sector Business ................... 46

Institute of Business & Technology

Impact of Government Debt on Economic Growth of Pakistan

CHAPTER NO.1 - INTRODUCTION

Institute of Business & Technology

Impact of Government Debt on Economic Growth of Pakistan

CHAPTER NO.1 - INTRODUCTION

Government debt means the central government borrowing to ensure it can

departments or agencies may issue their own bonds to finance expenditure.

Institute of Business & Technology

Impact of Government Debt on Economic Growth of Pakistan

Institute of Business & Technology

Impact of Government Debt on Economic Growth of Pakistan

Institute of Business & Technology

Impact of Government Debt on Economic Growth of Pakistan

To find out the impact of government debt on economic growth.