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 growth pace. 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. Besides, due to the less availability of funds for financing and higher in taxes for repayment, hampers growth that results in shrinking of the repayment capacity of debt. It also leads towards crowding out effect as well as has negative impact on the foreign as well as on domestic investment and developmental plans of the government.
The external debt exerts significantly negative impact on growth of country economy. This assured the existence of debt overhanging in Pakistan in both long and short run. Labour force affect GNP negatively in long run and short run as well, but in short run impact is insignificant. Pakistan faces serious debt problem, which threaten the future of the country economy. Burden of external debt and debt servicing have continued to grow over time.
Economic reforms process is a clear progression towards the deregulation for the growth economy. Petroleum products, gas, energy, agricultural commodities and other key inputs prices are mostly determined by markets. More importantly, taxation reforms have been prominently on the government's agenda, with no real reforms undertaken.
There are three main indicators of debt burden as;
Export Receipts: It measures the ability of debt repayment and creditworthiness of a country. According to the World Bank Report, when debt of a country go beyond 20% of its export earnings then its debt becomes uncontrollable.
Foreign Exchange Earnings (FEE): This is another important indicator of indebtness of a country.
Growth Domestic Product (GDP): This determines the burden of debt burden on the country's income. As Debt service to GDP ratio goes up, increase in the burden. As a research by Nagassam C.A, (2005) employed a model and highlighted that higher the debt service ratio will be, the lower the GDP will be and it will create constraint for external debt capacity of nations.
Fiscal as well as real sectors of the economy are strongly linked to public and foreign aid through economic variables. But, it appears that it turns out that the deficiency in savings and its effects on the BOPs is the basis of foreign aid. While, on the other hand, the budget deficit is the major cause of public debt. The rationale behind this is that level of debt, and the rate of growth of public debt should not unduly limit the flexibility of country's monetary, fiscal and exchange rate.
Pakistan's aid dynamics has undergone substantial changes since FY2007. Due to non availability of sufficient funds from the external sources, the financing focus shifted towards domestic sources that led to shortening of maturity profile of public debt. A confluence of unfavourable factors including lower GDP growth, devastating floods, severe energy shortages, haemorrhaging PSEs (public sector enterprises), high inflation, weak security situation and global economic recession resulted in higher fiscal deficits in the recent past.
Debt level depends on the debt paying capacity of the economy i.e. average income, export earnings, remittances and revenue generation capacity.
Debt burden can be measured in terms of stock ratio i.e. Debt to GDP and flow ratios i.e. Debt to revenue, external Debt to Foreign exchange Earnings. It is common practice to measure external debt burden as a percentage of GDP. However, it makes more sense to measure debt burden in terms Debt to revenue, external Debt to Foreign exchange Earnings of because they reflects more accurately on repayment capacity as GDP changes do not fully translate in to revenues particularly in case of Pakistan where taxation machinery is weak and taxation systems are also inelastic.
The total debt was Rs.10, 709 B as at June 30, 2012, and an increment of Rs.1, 788 B or 20% higher than the debt stock at the end of 2011. Government have taken Rs.1, 086 billion from Public debt and Rs.62 billion from foreign aid to finance operations. Approximately, US$ 3.3 billion were accumulated to the external debt stock owing to depreciation of US Dollar against other major international currencies and around Rs.27 billion was accumulated by depreciation of Pakistani Rupee against the United States Dollar. US dollar Depreciation against other major currencies caused public debt to increase by approximately US $3,300 million in the foreign currency component.
On the other hand, Increase in demands of the government budget during 2010-11 due to security meant decrease in the fiscal deficit. Secondly, lower GDP growth, energy shortages, lead towards a revenue shortfall; situation was complicated by the severe floods by putting additional burden on operations. But on the other hand, higher international prices for textile products had a positive impact on PTB (Pakistan Trade Balance).
Relationship of External Debt with GDP
Malik, Hayat, and Hayat (2010) analyze the relationship between foreign aid and economic development for the period 1972 - 2009 of Pakistan. The result shows that external debt is negatively relates to the economic growth. There results shows that increase in foreign aid will lead to decline in economic growth.
Hameed et al. (2009) on Pakistan explain the short run and the long run relationship between foreign aid and economic development. Annual time series data from 1970 to 2008 was taken to analyze the effect of GDP, debt repayment, revenue on her economic development. The study results show that debt burden is negatively related to the productivity of labour and capital, thereby affecting economic development.
Chaudhary and Ali (2009) analyzed external debt up to the year 2009-10 and presented an measure to reduce debt burden. They proposed to increase savings as measures to overcome the problem. According to them, Pakistan will be able to increase its savings by 3 % and it can significantly reduce dependence on foreign resources. They focused on projection of Pakistani foreign debt. They projected the foreign debt for the period of 2009-10 to 2014-15. The empirical findings of the study are consistent with economic theory. Pakistan's foreign dependence will be doubled by the year 2015 in comparison to previous researches. Similarly, its debt servicing as a % of Growth national product will be more than square by the year 2015. They gave trade policy as an alternative strategy to debt and suggest that if Pakistan can reduce imports by 2 % and increase exports by 2 %; borrowing can then be decrease by a considerable amount.
Patillo et al. (2002, 2008) examined relationship of the total external debt and the GDP rate for 61 countries, for the period 1978-2008. They analyze out a backward bending curve for growth with a debt to growth strait line relationship at certain lower levels of national debt and adverse relationship at other higher levels. This resulted that only after a certain threshold has been reached, effects of over debt are likely to occur.
Effectiveness of External debt
Rahim khan (1998) examined the yearly basis changes in two indicators of economic development; first is the domestic savings in then the net economic receipts on economic development of Pakistan. The result suggests that regression of Ordinary Least Square using the years 1970 to 1990 as sample years. Regression equations for savings provided negative coefficients of correlation for mobilization of resources between foreign aid and domestic efforts. Aids in grant also have a positive impact on economic development after a year of actual disbursement, but its estimated coefficient is then not significant.
Afxentiou and Serletis (2006) said that to protect future credit-worthiness, Pakistan has initiated certain restraining measures to minimise inflationary pressures and to protect its exports like many other countries of the world. Since there is a, however, substantial time-lag for these measures to work through the economy their way, its development is adversely effected from delays in their effectiveness.
Helene Poirson, and Catherine Pattillo (January 2006) analysed that Channels through which foreign debts impacts growth, over the period 1970-08. In the late 1990s, policymakers around the world have been curiously concerned that high external indebtedness in many countries is limiting development. In Pattillo and Ricci (2006) (known as PPR), they found that empirical evidence for a nonlinear impact of debt on growth: at lower levels, debt has positive impact on development; but certain thresholds or turning points, additional debt begins to have a adverse impact on development.