Govt should ask for subsidised loans or such funding that can be repaid in local currency
Net financial inflows, though tepid during 1HFY25, are expected to improve as a sizable part of official debt repayments has already been made. photo: file
LAHORE:
The capitalist system is based on debt. Business firms and governments are net borrowers in this system while households are net lenders.
There are two types of debt: domestic and external. A government can never default on the domestic debt but it may default on the external debt. On this basis, the external debt may create problems for the people.
Every year, the fiscal deficit contributes to the debt stock. As far as the case of Pakistan is concerned, the fiscal deficit is mainly financed through domestic sources while the share of external one was around 4% in FY 2024 and increased to 9% in FY 2025.
External financing is quite significant in the era of financial globalisation. Most of the developing economies are relying on external financing to meet their capital requirements. In Pakistan, the external debt-to-GDP ratio was around 24% in FY 2025, whereas the external debt-to-total public debt ratio was around 32%.
The breakdown of external debt shows that Pakistan owes to multilateral and bilateral creditors. It owes around 57% to the World Bank, Asian Development Bank and International Monetary Fund (IMF), which are termed multilateral sources.
In addition, it owes around 26% to bilateral lenders. The bilateral debt also contains deposits from friendly countries while the rest is commercial debt comprising Eurobonds/Islamic Sukuk and short-term loans from international banks.
Although foreign loans from the multilateral sources command low interest rates, there are strings attached to them. When the country faces balance of payments (BOP) crisis, it has to meet the conditionality clause of the IMF to secure the facility. Other multilateral banks wait for approval of the IMF and suspend their assistance till the loan facility is approved by the Fund.
On the other hand, bilateral loans have inflexible interest commitments. Lenders usually stick to their conditions. Though commercial loans have flexible interest commitments, they command higher interest rates. That is the reason Pakistan has to pay high interest rates on Eurobonds, the Sukuk and short-term loans.
From the perspective of economic development, the external debt or foreign currency loans are not effective. The country has to produce exportable surplus to earn dollars to service this type of debt. If debt servicing becomes difficult, it has to refinance the foreign currency loans by paying a much higher interest rate. Hence, currency and refinancing risks remain despite meeting the international benchmarks.
Since the Pakistani economy is constrained by BOP, the foreign currency loans ease this constraint for a short period of time. In other words, these loans just postpone the problem of foreign trade. A developing economy has to import raw materials, semi-finished manufactured or intermediate products and basic food necessities to meet requirements of the people. When the country faces a BOP crisis, it has to curtail these imports.
Such imports are necessary to keep the wheel of economy moving. Any reduction in such imports slows down the economy. For instance, the reduction in industrial imports will slow down the industrial output which, in turn, reduces the level of GDP.
Considering the current productive structure of the economy, the government should seek cheap development finance from the external sources. It should try to secure subsidised loans either from the multilateral institutions or bilateral sources. In the absence of subsidised external loans, it should seek loans which could be repaid in local currency.
In a nutshell, cheap external development finance is quite significant from the perspective of economic development. Financial diplomacy can play an important role to get subsidised finance from the external sources. Last but not least, the government should prefer loans repayable in local currency to minimise the currency risk.
The writer is an independent economist and has authored a book: Pakistan’s Structural Economic Problems in the era of Financial Globalisation
