BY the end of the 1990s, high levels of debt in developing countries caused by the pursuit of irresponsible fiscal policy had begun to receive greater attention from policy makers. High levels of indebtedness made countries more vulnerable to shocks, diminished the effectiveness of fiscal and monetary policy, discouraged investment and negatively affected economic growth.
Commitment to fiscal discipline over a prolonged period was recognised as essential for maintaining macroeconomic stability, thus promoting economic growth and job creation. Keeping in view the macroeconomic difficulties faced by Pakistan in the 1990s as a result of large fiscal deficit (7 percent of GDP, on average) with the consequential rise in public debt, the government in power at that time put together a rule-based fiscal policy in 2002-03, which was later approved by parliament in June 2005 as the Fiscal Responsibility and Debt Limitation Act. The act was meant to inject financial discipline in the country.
There were five key elements of the act. These included: (i) within a period of 10 years beginning from July 1, 2003 public debt not exceeding 60 percent of GDP beyond June 2013; (ii) eliminating revenue deficit by June 2008 (iii) reducing public debt by at least 2.5 percentage point of GDP each year until June 2013; (iv) not issuing guarantees to the borrowing of public service enterprises (PSEs) by more than 2.0 percent of GDP in a given year; and (v) maintaining the level of spending on social sector and poverty-related programs above 4.5 percent of GDP in a given year and ensuring that expenditure on education and health is doubled in terms of percentage of GDP by June 2013.
The law performed exceedingly well until June 2007 since not only were all key performance targets met but, in some cases, specified targets were exceeded. For example, public debt declined from 75.1 percent of GDP in 2002-03 to 55.4 percent in 2006-07 and revenue balance (total revenue-current expenditure) – a measure of the government’s savings or dis-saving, which remained in deficit to an average of 3.1 percent of GDP during 1997-98 to 1999-2000 – shrank to 0.9 percent of GDP by 2006-07 and was projected to achieve a surplus of 1.0 percent of GDP in the target year (2007-08). Social sector and povertyrelated expenditure continued to receive top priority and the amount allocated was close to 6 percent of GDP. The government remained within the required limit of issuing new guarantees up to 2 percent of GDP. Expenditure on education and health was also growing and there were indications that it would double by June 2013.
Some key elements of the law have remained in violation since 2007-08. For example, public debt increased from 55.4 percent of GDP in 2006-07 to 61.5 percent by 2011-12. Instead of registering a decline, public debt continued to rise. Revenue deficit, instead of turning into a surplus, surged to over three percent of GDP. Such an outcome was never in doubt given the irresponsible fiscal behaviour of the government over the last five years.
Pakistan’s current economic conditions provide a textbook example of the adverse consequences of growing indebtedness. It has made Pakistan more vulnerable to shocks and crisis, diminished the effectiveness of fiscal and monetary policy, discouraged both foreign and domestic investment, slowed economic growth, given rise to unemployment and poverty, and put the exchange rate under severe pressure. At present, foreign exchange reserves are declining and the country has entered into a debt repayment crisis.
The current fiscal responsibility law is expiring in June 2013. Pakistan needs a new fiscal responsibility law; the present government has no desire, commitment and capacity to undertake such exercise. The caretaker regime must initiate the exercise by forming a select committee of experts to prepare a new law that can be passed by the new parliament. To increase the credibility and operational relevance of the law, some refinements to the existing law will be required.
The new law should have a life of 10 years beginning from July 1, 2013. However, Pakistan needs to define medium-term debt burden goals that can become an integral part of the law. Public debt burden goals should be defined in terms of GDP and total revenue. In a sense, revenues are much better indicators of the government’s ability to service debt than GDP. Pakistan needs an external borrowing strategy, linking it to the fiscal