A Review on Fiscal and Debt Policies in Pakistan

ABSTRACT

Pakistan has been pursuing an active albeit expansionary fiscal policy since 1970s. In the mid-1970s to early-1980s, such policy choice was manifested in externally financed development spending, primarily in the form of investment in public enterprises. Despite excessive deficit financing, Pakistan’s economic performance never took off; rather, it remained on a path of truncated growth which, in turn, created structural hurdles like low productivity, poor investment climate, and higher unemployment. Likewise, deficit financing has been threatening the sustainability of fiscal framework as excessive public spending is not accompanied by corresponding enhances in domestic revenues. Consequently, these policies have caused persistence in fiscal deficit and the accumulation of public debt over time. These woes are added further by persistent deficit in external accounts and, the resultant depreciation of Pakistani Rupee, which has havocked the cost of debt-servicing over the same period. Given the history of incessant macroeconomic imbalances; currently, Pakistani economy has been trapped into a vicious circle of stagflation and low growth prospects amid unfunded losses of the State Owned Enterprises (SOEs), government guarantees to the Independent Power Producers (IPPs), unsustainable debt and huge cost of debt-servicing, sky-rocketing prices of the essential items, frequent though unsuccessful bail-outs of the IMF, low credit worthiness and negligible level of investment among others. This review is focusing on a detailed analysis of Pakistan’s fiscal and debt policies, with a view to provide a framework for resolving the structural economic woes that the country has currently been faced with.

INTRODUCTION

Fiscal policy in general is used to manage macroeconomic framework through the use of public spending and tax policies. In fact, it is aimed to steer variables like aggregate demand, inflation, employment, economic growth, debt etc. In this way, it is instrumental in stabilising the fluctuations in business cycles and regulating economic output, especially when markets have frictions (Ali, et al. 2018; Ali & Khan, 2020). For instance, during recession, governments usually lower tax rates or boost spending to increase demand and spur economic activity. Conversely, to combat inflationary pressures, governments may raise tax rates or cut spending to cool down pressures on the aggregate demand. Nevertheless, in all of its shapes, policy making and execution at fiscal level is conducted by elected and non-elected government officials. In Pakistan, fiscal policy is executed through its annual budgetary processes where allocations for spending heads and revenue targets are set at the beginning of each financial year. With regard to its history, fiscal policy in Pakistan originated in the same way as was in other developing countries where it was basically used as an instrument for industrial development. In the mid-1970s to early-1980s, Pakistan’s fiscal policy was based on deficit financing which was facilitated by external aid and credits at concessional rates. Especially, it was manifested in externally financed development spending as well as investments in State Owned Enterprises (SOEs) in those years (Haque & Montiel, 1992). The availability of credit at concessional rates at both the external and domestic markets though facilitated the expansion in public sector at that time but it were the beginnings of persistence in fiscal deficit as there was no corresponding increases in domestic revenues. The situation was chronic at both sides as there was no persistent growth which could raise the potentials for tax revenue; and, also, tax policy was not congruent which was largely based on preferential tax exemptions and concessions. In the later years (late 1980s and 1990s), the successive governments were unable to bring fiscal deficit down as neither could they achieve significant reductions in public expenditure nor could raise domestic revenue (Khan, 2024). As a result, Pakistan has experienced debt accumulation over most of its history.

Though, in Pakistan’s case, deficit financing led to the accumulation of debt but it is usually the fiscal policy which can be instrumental in managing debt in addition to its impacts on aggregate demand, growth, and inflation. If we look at the global history of fiscal policy, governments usually resort to printing money or raising debt when tax revenue is not sufficient to finance public spending. Even they go for external borrowing in addition to domestic borrowing, especially when they are unable generate adequate resources domestically (Jalil, 2020). Debt by itself is not bad when it is used as an instrument for spurring economic growth; however, it is bad when there is no capacity to repay debts. In developing countries like Pakistan, we have experienced significant lack of such a capacity. In other words, repayments in such cases are usually associated with sustainability issues, especially when the governments are unable to repay the existent debts through their domestic resources. For instance, we have recently observed default in Sri Lanka and, similarly, the risks of default were looming on Pakistan. Alternatively, debt beyond certain limit or unsustainable debt have severe repercussions for the longterm economic development of the indebted country as it not only crowds-out private investment but also worsens the credit worthiness of the country. Moreover, in the framework of overlapping generation models, unsustainable public debt is considered to be inversely associated with the long-run economic prosperity as savings, which are supposed to be used for future generations, are spent on servicing higher public debt. As, in case of Pakistan, the existing costs of debt servicing is around 50 percent of Pakistan’s total budgetary outlay, implying larger burdens for future generations as is prophesied in the famous Ricardian Equivalence. This, in other words, implies that unsustainable debt is costly not only in terms of current budgetary process but also in terms of worsening future’s economic growth. In this review, the focus is on the persistence of Pakistan’s fiscal deficit and its interaction with its public debt. Especially, we have two objectives. First, we want to see how persistence in fiscal deficit or budgetary support through borrowing has accumulated Pakistan’s debt stock or what has caused such alarming situations with regard to debt obligations. Second, we want to review the relevant literature in this regard in order to develop some general propositions with regard to Pakistan’s fiscal and debt policies. Rest of the study is organised in five sections. Section 2 overviews Pakistan’s persistence in fiscal deficit and its implications on the accumulation of public debt. In Section 3, we discuss debt sustainability issues in Pakistan, with particular focus on the relevant literature on Debt Sustainability Analysis (DSA). Likewise, in Section 4, we cite the literature and discuss the response of fiscal policy to the accumulation of debt which is mainly manifested in Fiscal Reaction Function (FRF). Section 5 is with regard to the potential implications of Pakistan’s fiscal deficit and debt for other macroeconomic variables. Also, in this section, we elaborate on the post Budget 2024-25 and Post Finance Bill 2024-25 scenario in order to highlight the prospective hardships that are currently faced by majority of the economic agents. Finally, in Section 6, we conclude with the purpose to provide a framework which could bring fiscal deficit and debt down to the manageable levels.