The economics of public debt is intriguing as well as fascinating! In interest-based capitalistic system, one cannot underestimate the value of debt. The system is designed such that economic progress and growth are made subject to ever-increasing prices of goods and services. The phenomenon of increasing prices is sustained by a corresponding increase in money stock through additional printing of currency. The additionally printed currency, going into an economy’s banking system, generates further money by way of credit expansion. The difference between the currency circulating in the economy and total customer deposits in the entire banking system represent the invisible wealth created by the debt system.
The credit money so generated earns interest to keep the banking system afloat. While individuals also make use of credit money, business and industry are the main consumers of this invisible wealth. Individuals, more often than not, use credit for unproductive purposes, but business and industry almost invariably use it for the production of goods and services. The interest money paid into the banking system by the business and industry is incorporated in the prices of goods and services. Interest thus helps keep the prices of goods and services in inflationary mode as stagnant and falling prices spell doom for the system. Abruptly rising and falling prices are usually linked to speculation; stocks, oil and gold are the example.
Business debt is the bloodline of corporate sector. The ever-going and ever-increasing business competition compels the corporate sector to make use of credit money to carry out leveraged operations. A prudent leverage implies keeping the business within safe waters. High-leveraged businesses live dangerously. For different kinds of businesses, there are different safe leverage limits. The central banks often provide guidelines to the banks in this regard. Leverage is explained by the relationship between the equity and debt of a business.
Like the corporate sector, economies too have to make use of borrowed money. The money may come from domestic as well as foreign sources. In case of economies, the need to borrow arises either to meet the fiscal and foreign trade deficits or to carry out development projects. The sum total of domestic and foreign borrowings is called public debt and is often measured by its relationship with the economy’s gross domestic product (GDP). A universally accepted safe benchmark is 60%. While this measure reveals an economy’s level of indebtedness, it hardly provides a meaningful insight into a country’s real economic health unless viewed alongside other economic indicators such as economy’s rank by GDP, per capita income, technological advancement level, growth potential, fiscal management, inflation, employment etc. Pakistan has a debt to GDP ratio of 63.3%, much lower than those of a number of developed economies. But when viewed alongside other economic indicators, the situation appears almost appalling. Large fiscal deficits, crippling trade imbalance, high incidence of tax evasion, rampant corruption, destabilizing energy crisis, all combine together to paint a bleak economic picture. The leverage afforded by high public date is not being used for productive economic purpose.
TABLE SHOWING DEBT TO GDP RATIO OF PAKISTAN AS COMPARED TO A FEW DEVELOPED ECONOMIES
The burden of high public debt becomes more telling when meager foreign reserves are used to service debt and principal pay off. An Oxford Analytica briefing suggests: ‘Debt is unsustainable for most countries if the debt-to-GDP ratio is projected to grow without limit given existing policies. The ratio of debt-to-GDP that a country can sustain without risk of a sovereign debt crisis is determined by its primary surplus … The amount of revenue a government receives and the interest rate at which it can borrow determines the primary surplus needed to stabilize the debt-to-GDP ratio.’
Our persistently high fiscal deficits and unusually high borrowing rates (we have recently borrowed from the international bond markets $3 billion at rates that are 500 basis points in excess of the corresponding US treasury rates) speak of the fragile state of our economy. Developed economies deliberately prepare deficit budgets and use the instruments of deficit financing and public debt to boost their economy. Public debt is decidedly a double-edged sword; you can cut with it either way.
TABLE SHOWING DEBT-TO-GDP RATIO OF SOME OF THE ASIAN COUNTRIES