Public debt: By: Naheed Akhtar

Public debt:

Public debt is the debt owned by the federal/central government. It is also called the national debt, which is due or owing by the government of a state or nation. The terms is generally applied to national or state obligations and dues, and would rarely, if ever, be construed to include town debts or obligations. The operations of a government are normally financed through public debt. Government debt is one method of financing government operations, but it is not the only method. Governments can also create money to monetize their debts, thereby removing the need to pay interest. But this practice simply reduces government interest costs rather than truly canceling government debt. Government usually borrows by issuing securities, bonds and bills.

As the government draws its income from much of the population, government debt is an indirect debt of the taxpayers. Government debt can be categorized as internal debt (owed to lenders within the country) and external debt (owed to foreign lenders). Sovereign debt usually refers to government debt that has been issued in a foreign currency. Another common division of government debt is by duration until repayment is due. Short term debt is generally considered to be for one year or less, long term is for more than ten years. Medium term debt falls between these two boundaries. A broader definition of government debt may consider all government liabilities, including future pension payments and payments for goods and services the government has contracted but not yet paid.

 Debt is not an unmixed blessing. Rather, it is a two-faced phenomenon. One face looks forward to achieve economic well-being and prosperity through increased production, lowered unemployment, and raised standards of living. While the other face sets eyes on economic disaster as a sequel to recession, unemployment and hyperinflation. Thus, debt is both a blessing and a curse, deciding factors being its size, trend, cost nature, purpose, etc. By controlling these variables, the "beastly instinct" of the debt can be tamed to serve the set goals. Alternatively, the giant devours everything that falls into its folds.

Pakistan’s economy is the 27^th largest in the world in terms of purchasing power parity and 44^th in terms of GDP. Over the years Pakistan has failed to collect enough revenues for financing of its budget. Consequently, the problem of twin deficits emerged and to finance the developmental activities government has to rely on public external and domestic debt. The positive effects of public debt relate to the fact that in resource-starved economies debt financing if done properly leads to higher growth and adds to their capacity to service and repay public debt. The negative effects work through two main channels— i.e. Debt Overhang and Crowding Out effects. The present study examines the consequences of public debt for economic growth and investment in Pakistan for the period 1972-2009. It develops a hybrid model that explicitly incorporates the role of public debt in growth equations. As the some variables are I (1) and other are I (0) so Autoregressive Distributed Lag(ARDL) technique has been applied to estimate the model. Study finds that public external debt has negative relationship with per capita GDP and investment confirming the existence of Debt Overhang effect?. However, due to insignificant relationships of debt servicing with investment and per capita GDP, the existence of the crowding out hypothesis could not be confirmed. Similarly, domestic debt has a negative relationship with investOver the years Pakistan has failed to collect enough revenues to finance its budget. Consequently, it has been facing the problem of twin deficits and resultantly to finance their developmental activities government has to rely on public external and domestic debt. The positive effects of public debt relate to the fact that in resource-starved economies debt financing if done properly leads to higher growth and adds to their capacity to service and repay external and internal debt. The

Negative effects work Through two main channels--i.e., “Debt Overhang” and “Crowding Out” effects. Examining the consequences of public debt for economic growth and investment in Pakistan for the period 1972-2009. It develops a hybrid model that explicitly incorporates the role of public debt in growth equations. Study finds that public external debt has negative relationship with per capita GDP and investment confirming the existence of “Debt Overhang effect”. However, due to insignificant relationships of debt servicing with investment and per capita GDP, the existence of the crowding out hypothesis could not be confirmed. Similarly, domestic debt has a negative relationship with investment and per capita GDP. In other words, it seems to have crowded out private investment. and per capita GDP. In other words, it seems to have crowded out private investment.

Needless to point out, government can finance its budget and development efforts by borrowing or taxing the output. However, taxes tend to distort the structure of relative prices, borrowing, if pushed beyond the carrying capacity of an economy, creates problems of intergenerational equity, and it can cause a transfer of resources that tends to be undermining growth. Yet borrowing has to be done to finance public expenditure to increase social welfare and promote economic growth.

Public debt can be classified as sum of external debt and domestic debt. As far as the relationship between external debt and economic growth is concerned, a reasonable level of borrowing is likely to enhance economic growth, through capital accumulation and productivity growth  Because at early stages of development, countries have small stocks of capital and they have limited investment opportunities. External borrowing for productive investment creates macroeconomic stability , external debt is also been seen as capital inflow having positive effect on domestic savings, investment and economic growth; it implies that foreign savings complement domestic savings to cater for investment demand (Eaton, 1993). However, high level of accumulated debt has an adverse effect on rate of investment and economic growth. Most broad rationalization of the adverse effect of debt is “debt overhang” effect. If there is some likelihood that in future, debt will be larger than the country’s repayment ability then anticipated debt-service costs will depress further domestic and foreign investment.

The other channel through which debt obligations affect economic growth ” effect. If a greater portion of foreign capital is used to service external debt, very little will be available for investment and growth. Debt-servicing cost of public debt can crowd out public investment expenditure, by reducing total investment directly and complementary private expenditures indirectly.

Debt burden and debt service obligations have reduced the investment and economic performance. In developing countries, policy makers and international organizations have given domestic debt far less attention as compared with external indebtedness. Issuing domestic debt, 3whether to finance fiscal deficit or to mop up monetary liquidity, involves a complex assessment of the costs and benefits to the economy. The justification behind creation of domestic debt in poor countries is that it kindles development of deep and liquid internal financial markets, protect countries from unfavorable external shocks, and mitigate foreign exchange risk. Domestic debt can crowd in risky private sector investment by protecting bank balance sheets and profitability. As such, investments are more proficient compared with investment associated with low risk. Most important concern about domestic debt is crowding out effect on private investment. When governments borrow domestically, they use domestic private savings, otherwise that may have been on hand for private sector lending. In turn, smaller residual pool of loan able funds was available in market to elevate the cost of capital for private borrowers. It results in dropping private investment demand, and therefore capital accumulation, growth and welfare. Domestic debt is also viewed as more expensive in comparison to concessionary external financing. As a result, interest load of domestic debt may absorb important government revenues and thus crowd out pro-poor and growth enhancing expenditures. High-yielding government domestic debt held by banks can make them self-satisfied about costs and decrease their efforts to mobilize deposits and fund private sector projects.

 Investment is the basic channel through which public debt affects growth. Therefore, it becomes very important that the relationship between debt and investment is explored, which is what this study also seeks to do.

In Pakistan, public external debt has a negative and significant relationship with per capita GDP and investment, both in the short run and in the long run. Therefore, there is strongly confirm the existence of “Debt Overhang effects”. On the other hand, only in the short run debt servicing has a negative and significant relationship with per capita GDP. But from this evidence we cannot infer the existence of the “crowding out effect” because debt servicing does not seem to significantly affect investment. Domestic debt has a negative and significant relationship with investment, suggesting that it has tended to crowd out private investment. However, domestic debt does not have significant relationship with per capita GDP; and that investment has a positive and significant relationship with per capita GDP.various policy implication have emerged.

REMEDIES:

Accumulation of public debt undermines the ability of these countries to provide essential services to their citizens, such as health and education. The financial and economic policies adopted by Arab countries to reduce the debt, to meet the financial requirements of the government, and to provide the cash needed to pay off this debt did not succeed in achieving these goals. Instead, they led to the accumulation of public debt that has reached excessive levels. The efforts aimed at reducing the public debt and providing the cash needed to pay off the debts of these countries revolve around three possibilities:

The first is related to the increase in government revenues. It is known that the volume of government revenues is linked to the collection of taxes and customs. Arab countries are suffering from a clear imbalance in this context due to the lack of frameworks and effective mechanisms for collecting taxes and customs, the absence of trust in Arab governments and their programs, in line with the principle of 'no taxation without representation'; in addition to the weakness of economic activity in a number of Arab economies. Several Arab countries have resorted to changing tax and customs laws and applying more effective criteria for the collection of taxes.

The second possibility is linked to rationalizing government expenditure: some Arab countries have resorted to reducing the level of subsidies for the citizen's essential needs, such as bread and fuel. They have also denationalized some public sector institutions to reduce the government payroll and improve the public sector performance. According to a number of studies, the public sector in Arab countries is still suffering from weak management and limited effectiveness. These policies have drawn a wave of protests from the areas that have been affected by these policies.

The third possibility pertains to international aid: over the past years, international financial assistance has helped a number of Arab States, such as Jordan and Egypt, to cover a great part of government expenditures. This money was used to put off the process of comprehensive economic reform, instead of using them to reduce the side effects that could accompany the economic transformation resulting from short- and medium-term reforms. These can be remedies to deal with the problem of public debt.

1)Heavy reliance on external debt must be discouraged. Public external debt almost always results in deteriorating economic growth process, partly because it also adversely affects investment.

2) As domestic debt has negative relationship with investment and per capita GDP. Therefore, the policy makers should not use the domestic debt to finance the fiscal deficit rather there is a dire need to enhance efforts to stimulate the revenue or reduce the current expenditures.

3) The present study shows that openness is growth enhancing however if the country wants to accelerate economic growth with the help of trade and openness then this policy must be supplemented with pro-poor policies. It may be interesting to highlight new areas of research that the present study suggests. In line with Pattilo (2002) and various others, this study is also unable to find out the full significance of “crowding out effect” of debt servicing, but there is consensus that debt servicing results in reducing the development expenditure. To test this argument further it is suggested that an empirical study may be conducted that explores the relationship between 3D‟s of public expenditure i.e. Development Expenditure, Defence Expenditure and Debt Servicing Expenditure. In that study by analyzing the interlink-ages between 3D‟s, the government preferences for the development expenditure may be further explored.