Assessment of Public and External Debt Sustainability Using Debt Dynamics Equation Approach: A Comparative Study of Pakistan and India

Abstract

The study examines the sustainability of public and external debt burden of Pakistan and India for the period 1971–2017. The debt dynamics equation for public debt uses two components for the analysis of public debt sustainability, namely, interest rate–growth rate differential and differential of primary budget balance-to-GDP and change of reserve money-to-GDP ratio. The equation for external debt dynamics also uses two components for the assessment of external debt sustainability, namely, current account balance-to-exports ratio and differential of exports growth and interest rate. The significance of the approach used in the current study lies in the fact that in case of evaluation of countries’ debt sustainability, it is quite necessary to monitor debt trends along with emerging domestic and external vulnerabilities and systemic risks that threaten debt sustainability. This phenomenon has been captured through debt dynamics approach, which is used in the current study. The results are based on the estimation of two equations, namely, debt dynamics equation for overall public debt sustainability and debt dynamics equation for external debt sustainability. The results of the study indicate that primary budget deficit and current account deficit have played a significant role in the accumulation of public debt and external debt, respectively in Pakistan and India. The study concludes that public debt and external debt of Pakistan and India are sustainable but in a weak form.

Keywords

Public debt GDP primary deficit debt sustainability

I. Introduction

The public sector (government) and private sector use the tool known as borrowing in order to finance their investments that are necessary for the achievement of sustainable development. The tool of borrowing is also employed to cover the deficit (imbalance between revenue and expenditures). Higher levels of public debt could hinder economic growth and development. Debt must be wisely handled in both public and private circles. The international community often supports heavily indebted poor countries (HIPCs) to reduce their external debt burden. Simultaneously, domestic debt is also increasing in many countries. The domestic borrowing creates opportunities for financing, and it reduces currency mismatching for local lenders and borrowers. Still, the overhang of domestic debt could be costly and needs to be handled wisely like any other form of debt.

The significance of public debt sustainability is of critical importance in developing as well as advanced economies. Sharp short-term changes in default probabilities inherited from market prices, making public debt assessment difficult. The analysts must keep an eye on the structure of public debt, risks from political economy, macroeconomic aspects, and so on, while making sustainability assessments (Heylen, Hoebeeck, & Buyse, 2013). However, public defaults are very few in recent times in any developing or an advanced economy. The current research aims to estimate the sustainability of public debt as well as external debt and hence, providing an insight into the assessment of public debt sustainability in Pakistan and India.

The two approaches that were traditionally employed for the assessment of debt sustainability include analyzing stationary properties of debt and use of fiscal reaction functions of primary budget balance to debt ratio (Afonso & Jalles, 2017; Bohn, 1998; Chandia & Javid, 2013a). The fiscal reaction functions usually take overall public debt and ignore its composition and characteristics while making sustainability analysis. Several characteristics of sovereign debt provide information to the investors and capital markets regarding the pricing of new debt issuance and related secondary market transactions. The problems in debt servicing, that is, interest payments and repayment of current liabilities, or issuance of new loans, as one can witness in debt crisis, have consequences such as a drop of bond prices in the secondary market and increasing yields and risk premium. Under extreme crisis, default and debt restructuring cases might occur, since markets tend to see a country’s debt position as unsustainable (Afonso & Jalles, 2017).

Provided, the scarcity of default situations in recent history, analyzing the behaviour of different variables of fiscal and monetary policy, allows capturing probable default scenarios that could not be identified with the pure empirical approach. Another possible advantage of the debt dynamics equation is that it explains important fiscal mechanisms at work (Bohn, 1998). This study indicates that one can see the proof of corrective measures by investigating the reaction of primary budget balance (surpluses) to variations in debt-to-GDP ratio. A positive reaction indicates that the government is taking measure (reduction in non-interest outflows or increase in revenues). This mechanism is more appropriate than the time series assessment of single variable, that is, the debt-to-GDP ratio as the debt ratio is caused by some shocks, for example, variations in GDP, government expenditure or interest rate, which make it difficult to detect the mean reversion of debt ratio.

The primary objective of the study is to assess the public debt sustainability and external debt sustainability of Pakistan and India from 1971 to 2017. The reason for selecting two neighbouring countries, that is, Pakistan and India, is that these two countries were facing the debt-to-GDP ratio of 62 per cent in 2016 (Haver Analytics, 2018). It is worth mentioning here that the same level of debt as a percentage of GDP in both countries draws the motivation for analyzing debt dynamics of these two countries. Though the assessment of the sustainability of a public debt position is not readily transparent but depends on projections of different variables such as interest rates, economic growth rates, government revenues and expenditure. Therefore, year-wise assessment is done based on debt dynamics equation. The contribution of the current study is twofold: first, the study has derived a debt dynamics equation for the sustainability of public and external debt burden for the case of developing countries. Second, the study has estimated year-wise sustainability assessment of public debt and external debt of Pakistan and India. The year-wise sustainability assessment makes the study different and unique from the existing literature.

II. Public Debt Burden of Pakistan and India

Situation of Pakistan

Pakistan’s public debt-to-GDP ratio has been hovering around 65 per cent over the past 5 years (Ministry of Finance, 2018). The current level of this ratio, though higher than the trough seen in 2007, is lower relative to where it had stayed throughout the 1980s and 1990s. Compared to other emerging market economies, Pakistan’s standing is mixed: it has a lower debt-to-GDP ratio compared to India, Brazil, Sri Lanka and Egypt, but higher compared to most East Asian and Latin American countries (Khalid, 2016). An important aspect is that the public debt-to-GDP ratio in Pakistan represents a deviation from the ceilings prescribed under the Fiscal Responsibility and Debt Limitation (FRDL) Act, which has been in place since 2005. While comparisons presented earlier are important to put debt numbers into perspective, these do not speak anything significant about the sustainability.

For instance, we cannot infer that Pakistan’s public debt is more sustainable than Sri Lanka’s or Egypt’s or less sustainable than India’s. By the same token, the statutory slippage per se does not indicate looming debt distress. Although the GDP growth of Pakistan increased on average from 5 per cent in the 1970s to 6.5 per cent in the 1980s, it was the decline in growth rate to 4.4 per cent in the 1990s coupled with the high overall fiscal deficit of 6–7 per cent of GDP that adversely impacted the debt ratios. Public debt was 54.4 per cent of GDP in 1980, which increased to the unsustainable level of 103 per cent by 2000. The debt servicing liability also continued to rise, and in 1990, almost 43 per cent of total revenues were consumed to finance debt servicing, and by 2000, it reached almost 63 per cent (Khalid, 2016).

Situation of India

In the recent past, concern about fiscal sustainability has resurfaced in India due to high levels of debt, persistently high fiscal and revenue deficits, lower growth and unprecedented external imbalance. For instance, concerns over public debt sustainability were raised by the Twelfth Finance Commission in 2004 as the debt was rising faster than GDP from 1996 to 2003. Since 2004, the concern modestly eased due to comfortable foreign exchange reserves of around US$300 billion in 2009–2010. The resulting revenue buoyancy helped both Union and State governments to reduce the combined gross fiscal deficits to below 4 per cent of GDP by 2007–2008 (Reserve Bank of India, 2018).

However, the quantum jumps in fiscal deficits to over 8 per cent of GDP since 2008–2009 due to the expansionary fiscal policy to protect the economy from the global financial crisis, and the significant slowdown since 2011–2012 has raised concern about sovereign rating downgrades and the sustainability of fiscal policy in India. Besides, the current level of debt/GDP (around 70%) in India is far higher than the different Finance Commissions’ long-term target of debt/GDP below 60 per cent mark and poses a significant risk to macro stability. The record of current account deficit (CAD) of over 5 per cent of GDP in 2012–2013 is considered to have been the direct outcome of persistently high fiscal deficits since 2008–2009 in India. At present, the major challenge to policymakers in India is to revive high growth. But high growth cannot be revived without macro stability, and macro stability cannot be had with high debt and deficits.

III. Literature Review

The different school of thoughts developed a large body of macroeconomic literature: Classical, Keynesian and Ricardian on the issue of debt–deficit sustainability, debt dynamics and their role in the economy, which is supported by or occasionally disregarded by the empirical literature. The current section provides the review of empirical literature done in this area.

Barro (1989) tried to evaluate the behaviour of budgetary deficits in the context of the Ricardian approach. The author has also tried to prove the irrelevance of fiscal policy in case of budgetary deficits. The empirical findings of the study argued that interest rates, consumption and savings and current amount balance support Ricardian point of view, which states that fiscal policy is irrelevant and any reduction in current taxes will lead to high upcoming taxes. In case of Pakistan, Burney and Ahmad (1988) have performed an analysis of debt burden and debt servicing indicators and solvency situation by using critical interest rate approach and concluded that debt repayment capacity of Pakistan, in the long run, was not in good condition during 1973–1987. Spaventa (1987) has examined the growth of public debt and its sustainability. For making the debt growth sustainable, the tax burden is required to be raised above the socially acceptable level. The deficit situation, where remedies like revenue generation became ineffective and the monetary financing of deficit becomes relevant.

Bohn (1995) argued that government must satisfy and fulfil the requirements of the intertemporal budget constraint regardless of the level of interest rate. Bohn (1998) concluded that a positive reaction of primary surpluses to debt-to-GDP ratio shows the sustainability of the US fiscal policy for the period 1916–1995. Blanchard and Perotti (2002) studied the effects of variations in government expenditure and taxes on the growth of the US GDP. The results of the study indicate that government expenditures have positive consequences for output, while taxes have negative consequences. The issue of accumulation of debt and its sustainability and its impact on growth are studied extensively in developing economies. Tahir and Ahmad (1998), Hasan, Chaudhri, and Ahmad (1999), and Siddiqui, Siddiqui, and Kazmi (2001) conducted the comparison of various external debt burden indicators of Pakistan with averages of severely indebted low-income countries (SILCs), moderately indebted lower income countries (MILCs), HIPCs and all other developing countries from 1994 to 1997 and concluded that Pakistan is in a less comfortable position as compared to most of the countries.

Chaudhary, Anwar, and Tahir (2000) estimated the debt burden indicators of Pakistan, India, Bangladesh, Sri Lanka, Nepal, Maldives and Bhutan and concluded that Pakistan is in a relatively comfortable position as compared to some other South Asian countries. Chaudhary, Anwar, and Siddiqui (2001) investigated debt sustainability by using the Debt Laffer Curve approach for Pakistan, India, Bangladesh, Sri Lanka, Nepal, Maldives and Bhutan. The results indicate that external debt burden was sustainable for Pakistan, India, Bangladesh, Sri Lanka, Nepal from 1970–1971 to 1994–1995. Pasha and Ghaus (2001) indicated that determinants of change in the public debt-to-GDP ratio are as follows: the primary balance, interest rate–growth rate differential and depreciation of exchange rate. Similarly, the composition of change in domestic debt-to-GDP ratio was also evaluated. The study concluded that public debt-to-GDP ratio had risen substantially with 28 per cent during 1980–1995 in case of Pakistan.

Favero and Giavazzi (2007) focused on linkages between debt and the effects of fiscal policy. They have argued that excluding debt response can come up with inaccurate estimates of active effects of economic shocks. Bohn (2007) again found results in support of the sustainability of the US fiscal policy and found the strong positive reaction of primary surpluses to variations within initial debt burden. The assessment of debt sustainability is a part of the study by Ejaz and Javid (2009). The study has proposed a debt dynamics equation for the assessment of debt sustainability and external debt sustainability in developing countries. The primary focus of the study was Pakistan. The study has opted interest rate—growth differential and level of primary budget balance for the assessment of public debt sustainability and used interest rate on debt—export’s growth rate differential and current account balance for the assessment of external debt sustainability. The year-wise assessment public debt sustainability for Pakistan revealed that government debt remained unsustainable in Pakistan for most of the years during 1971–2008 (Ejaz & Javid, 2011).

The detailed analysis of public debt sustainability is the part of the study of Chandia and Javid (2013a). The fundamental purpose of the study was to test the debt sustainability of Pakistan through fiscal reaction functions. The findings of the study indicated that public debt of Pakistan is sustainable but its weak form of sustainability. The study found a positive relationship between the primary budget balance and debt ratio. The study has supported the arguments of Bohn (1998), which stated that surpluses respond negatively towards variations in government spending. The study has also indicated that both government revenues and spending have the capacity to adjust against accumulated debt to make it sustainable.

The identification of different factors contributing towards the accumulation of debt-to-GDP ratio is carried out (Chandia & Javid, 2013b). The study has derived a debt dynamics equation for the said purpose. The debt dynamics equation considers three factors, that is, interest rate-growth differential foreign exchange effect and primary budget deficit, as a reason for the change in the debt ratio. The study concluded that the primary budget deficit is the most contributory factor that leads the country towards excessive domestic and external borrowing and debt accumulation. The primary budget deficit is a result of wasteful government spending in South Asian countries included in the study.

Draksaite, Snieska, Valodkiene, and Daunoriene (2015) have tried to identify several methods from empirical literature for the evaluation of public debt sustainability. The article identified several factors that are necessary for the assessment of debt sustainability. The factors include the evaluation and assessment of risk associated with debt, risk management, the solvency of government, usage of borrowed funds, level of public debt, debt structure and nature of the fiscal and monetary policy. The study has emphasized on carrying out an in-depth analysis of the aforementioned factors in the sustainability assessment of public debt.

The study of Afonso and Jalles (2017) has focused on public finance sustainability and the composition of public debt. The study focused on 13 advanced economies from 1980 to 2012. The authors have calculated and estimated the response of debt-to-GDP ratio towards the primary budget surplus/deficit of countries considered in the study. Several indicators like foreign currency debt’s share, long-term debt share debt held by the central bank and marketable debt share play a vital role in keeping government debt on a sustainable path. Sustainability tends to decrease with the increasing share of short-term liabilities and difficulties in issuing long-term debt during the crisis period.

Chinese economic performance is slowed down since the start of the recent depression spell. Subsequently, the Chinese government has adopted the expansion of its fiscal policies. Cuestas and Regis (2018) have tried to analyze time series properties of public debt of China. The findings of the study revealed that Chinese debt accumulation is non-stationary. The most recent trend of the public debt in China is found to move towards the unsustainable path. The study foresees a rapid escalation in public debt problems of China until its economic growth enhances.

The sustainability of public debt is analyzed for OECD countries (Fournier & Fall, 2017). The study confirms the fiscal fatigue hypothesis as the response of primary balance towards debt ratio is non-linear. The study has also calculated debt limit for OECD countries. The results of the study indicated that high debt limit is about two-timed GDP for several OECD countries. The debt limit depends on the state of government behaviour, economic growth, market conditions and monetary policy.

IV. Methodology

Theoretical Framework

The study has looked at overall public debt sustainability and external debt sustainability through following debt dynamics framework suggested by Romer (2006) based on the government’s budget constraint of fiscal policy. The following equation describes the government’s budget constraint:

\int_{t = 0}^{\infty} e^{R (t)} ​ ​ G (t) ​ ​ ​ d t \leq D (0) + \int_{t = 1}^{\infty} e^{- R (t)} ​ ​ ​ T (t) d t ​

(1)

where G (t) and T (t) describe the government’s real purchases and taxes at the time(t), D(0) is initial real debt outstanding and R(t) denotes $\int_{r = 0}^{\infty} r (T) d t$ where r(T) is the real interest rate at time (T). The value of a unit of output at time (t) discounted back to time(0) is e^–R(t). The present value of government’s purchases of goods and services must be less than or equal to its initial wealth plus the present value of its tax receipts (net of transfer payments).

The government’s budget constraint does not prevent it from staying permanently in debt or even from always increasing the amount of its debt; if the growth rate of D is less than the real interest rate and growing D satisfies the budget constraint. Simply, the budget deficit is defined as that it is the rate of change in the stock of debt. The rate of change in the stock of real debt equals the difference between the government’s purchases and revenues, plus the real interest on its debt expressed as:

D (t) = [G ​ ​ ​ (t) - T (t)] ​ ​ ​ ​ r (t) ​ ​ ​ ​ D (t) ​ ​

(2)

Here, the right-hand side of (2) is referred to as the primary deficit, and the primary deficit rather than the total deficit better evaluates how fiscal policy at a given time is contributing to the government’s budget constraint. Therefore, rewriting the government budget constraint (1) is as follows:

\int_{t = 0}^{\infty} ​ ​ e^{R (t)} ​ ​ ​ [T (t) - G (t)] ​ ​ ​ ​ d t \geq D (0) ​

(3)

The budget constraint in Equation (3) describes that the government must run primary surpluses large enough in present value to offset its initial debt. The government budget constraint involves the present values of the entire path of purchases and revenues and not the deficit at a point in time. As a result, conventional measures of either the primary or total deficit can be misleading about fiscal actions’ contribution to the budget constraint. The first case takes account of inflation on the measured deficit; the change in nominal debt outstanding, that is, the conventional purchases and revenues plus the nominal interest rate on the debt. Let (B) denotes the nominal debt, the nominal deficit is therefore can be written as:

B (t) = P (t) ​ ​ ​ [G (t) - (T (t)] + i (t) ​ ​ ​ P (t) ​ ​ ​ D (t) ​ ​ ​

(4)

where P is the price level and i is the nominal interest rate; when inflation raises, the nominal interest rate for a given real rate rises. Consequently, interest payments and deficits rise. The higher interest payments are just offsetting the fact that the higher inflation is eroding the real value of debt. Nothing involving the behaviour of the real stock of debt, and thus nothing involving the government’s budget constraint is affected. The nominal interest rate equals the real rate plus expected inflation. This leads to rewrite the nominal deficit equation as follows:

B (t) = P (t) [G (t) - (T (t)] + [r (t) + π (t)] P (t) D (t)

(5)

B (t) = P (t) [D (t) + π (t) D (t)] ​ ​

(6)

Dividing both the sides of Equation (6) by the price level yield

\frac{B (t)}{P (t)} = D (t) + π (t) D (t) ​

(7)

That is, if the stock of debt is positive, higher inflation raises the conventional measure of the deficit even when the price level deflates it.

The second case considers the sale of an asset if the government sells an asset; it increases current revenue and thus reduces the current deficit. However, it also forgoes the revenue, which would have been generated in future. In case, the value of the asset equals the present value of the revenue it will produce, the sale does not affect the present value of the government’s revenue. Therefore, the sale affects the current deficit but does not affect the budget constraint.

The third case is an unfunded liability that is a government commitment to incur expenses in future that is made without provision for corresponding revenues. In contrast to an asset sale, unfunded liability and provident fund affect the budget constraints without affecting the current deficit. If the government sells an asset, the set of policies that satisfy the budget constraint is unchanged. If it incurs an unfunded liability, on the other hand, satisfying the budget constraint requires higher future taxes or lower future purchases.

Empirical Framework

The study has examined overall public debt and external debt sustainability by following the theoretical insights of debt dynamics suggested by Romer (2006). The present study analyzes the dynamics of the overall public debt and the dynamics of external debt separately. Public debt is the sum of domestic debt payable in domestic currency and public and publicly guaranteed external debt payable in foreign exchange. The theoretical model of the dynamics of public debt provides an overall assessment of the debt dynamics. The dynamics of debt payable in-home currency are different from the dynamics of debt payable in foreign currency. For example, in case of public debt payable in-home currency, the domestic real interest rate, GDP growth, primary balances are the important variables, whereas for external debt, the relevant variables are current account balance, foreign interest rate and depreciation of currency against the foreign exchange.

Assessment of Overall Debt Sustainability

The debt-to-GDP ratio varies over time because of the joint effects of certain macroeconomic variables namely the interest rate, the exchange rate, budgets deficit and GDP growth. This section assesses the impact of these factors on the debt sustainability in South Asian countries. The debt-to-GDP ratio rises when the real interest rate exceeds the real GDP growth, and the primary budget is balanced or in deficit. The analysis begins with the budget identity regarding government sector that could be written as follows:

P D + i B = Δ S + Δ B ​

(8)

where PD is a primary budget balance, that is, deficit, iB is servicing expense (interest payments) in the stock of public debt B, ΔS is a change in money reserves and ΔB is change in the stock of public debt.

Using lower case alphabets for the proportion of variables as part of GDP and writing GDP = PY that is, P for prices and Y for output.

p d + i b = s + \frac{Δ B}{P Y} ​

(9)

Taking $\frac{Δ B}{P Y} = Δ b + b (P^{^} + Y^{^}) $ from Equation (7) and substituting in (8)

p d + i b = s + Δ b + b (P^{^} + Y^{^}) ​ ​

(10)

Rearranging

Δ b = p d + i b - s - b (P^{^} + Y^{^}) ​

(11)

Δ b = p d - s + i b - b (P^{^} + Y^{^}) ​

(12)

Δ b = p d - s + b (i - P^{^} - Y^{^}) ​

(13)

Δ b = p d - s + b (r - Y^{^}) ​

(14)

where b is the ratio of debt-to-GDP, pd is a primary budget balance as a percentage of GDP, s is change in money base as a percentage of GDP, Y^{^} is GDP growth rate and r is the rate of interest in real terms.

Assessment of External Debt Sustainability

The theoretical model for dynamics of external debt exclusively identifies variables that are relevant to the external sector accounts and model assesses their significance in contributing to external sector imbalances. To assess external debt sustainability, the factors that contributed to the evolution of the external debt between period t and t + 1 can be decomposed into the following factors: primary current account balance, foreign interest and growth rate and change in foreign exchange reserves (International Monetary Fund, 2001). The external debt relative to exports rather than a proportion of GDP can be expressed. External debt is considered in US dollars. The external debt dynamic equation can be written as:

Δ e = z + (i^{*} - g) e ​

(15)

Rearranging

Δ e = z - (g - i^{*}) e ​

(16)

where e is the external debt as a percentage of exports, i^* is the nominal dollar interest rate, g is the growth of exports and z is ratio of the current account balance-to-exports.

The significance of the approach used in current study lies in the fact that in case of evaluation of countries’ debt sustainability, it is quite necessary to monitor debt trends along with emerging domestic and external vulnerabilities and systemic risks that threaten debt sustainability. This phenomenon has been captured through debt dynamics approach that has been used in the current study.

Data

The study covers the period of 1971–2017, for which the data are available for the analysis of the sustainability of public debt burden of Pakistan and India. The data for analysis are collected from different issues of Pakistan Economic Survey, the website of Reserve Bank of India and International Financial Statistics (IFS) CD ROM (2008).

V. Analysis and Discussion of Results

Persistent deficits are financed through borrowing that piles up the national debt in the two countries of South Asia. As both, the overall debt and external debt have been rising; the later has risen much faster. The analysis in this section examines whether these debts are sustainable or not.

The Case of Pakistan

The estimations and results for Pakistan indicate that the debt-to-GDP ratio has a rising trend since 1971, and the change in the debt ratio is positive for the whole period. In 1971, the increase in debt as a percentage of GDP was just 0.011 per cent that reached 6.01 per cent of GDP in 1981, and it was 5.27 per cent of GDP in 1991. The change in debt ratio was 1.929 per cent in 2001, and it reached to 3.49 per cent in 2011 and 6 per cent in 2016. This change in debt-to-GDP ratio shows an intensity of increase in debt burden from 1971 to 2017.

During the period of analysis, the intensity of the increase in debt-to-GDP ratio was low, but the ratio has never decreased or reduced from 1971 to 2017. The ratio has a positive sign for all the years. The increasing trend in debt-to-GDP ratio shows that the debt burden of Pakistan has been increasing since 1971. The study has identified two factors that have the potential to affect the variations in the debt-to-GDP ratio of any country. The two factors that have the potential to influence debt-to-GDP ratio include interest rate–growth rate differential and primary budget balance–reserve money ratio differential. The positive sign of interest rate–growth rate differential indicates an increase in the debt-to-GDP ratio. The estimates of interest rate–growth rate differential remained negative for most of the years, which indicate that the differential has not played any role in increasing the debt burden of Pakistan over the period from 1971 to 2017.

The interest rate–growth rate differential indicated mixed results as the differential has increased for some years while declined in a few years, but the definite result of interest rate–growth rate differential is negative. This interest rate–growth rate differential shows that real interest rate in Pakistan has been under the control of Pakistani government and thus remained below the growth rate of the economy of Pakistan. Table 1 presents the results for analysis of sustainability of overall public debt burden of Pakistan.

Table 1.
Public Debt Sustainability Analysis for Pakistan

Year Change in Debt as % of GDP (Δb) (pd – s) (r – y^) Residuals Nature of (pd – s) Nature of (r – Y^) Nature of Public Debt

1971 0.000 −0.068 0.010 0.057 (pd – s) < 0 r > Y^ Unsustainable

1972 0.023 −0.071 0.015 0.079 (pd – s) < 0 r > Y^ Unsustainable

1973 0.064 −0.062 −0.079 0.204 (pd – s) < 0 r < Y^ Weak form sustainability

1974 0.069 −0.073 −0.232 0.375 (pd – s) < 0 r < Y^ Weak form sustainability

1975 0.037 −0.069 −0.164 0.270 (pd – s) < 0 r < Y^ Weak form sustainability

1976 0.032 −0.087 −0.039 0.158 (pd – s) < 0 r < Y^ Weak form sustainability

1977 0.028 −0.079 −0.029 0.136 (pd – s) < 0 r < Y^ Weak form sustainability

1978 0.072 −0.073 −0.040 0.185 (pd – s) < 0 r < Y^ Weak form sustainability

1979 0.052 −0.085 −0.008 0.145 (pd – s) < 0 r < Y^ Weak form sustainability

1980 0.068 −0.058 −0.070 0.197 (pd – s) < 0 r < Y^ Weak form sustainability

1981 0.060 −0.051 −0.074 0.186 (pd – s) < 0 r < Y^ Weak form sustainability

1982 0.070 −0.050 −0.079 0.199 (pd – s) < 0 r < Y^ Weak form sustainability

1983 0.064 −0.062 −0.012 0.138 (pd – s) < 0 r < Y^ Weak form sustainability

1984 0.038 −0.051 −0.007 0.096 (pd – s) < 0 r < Y^ Weak form sustainability

1985 0.080 −0.068 −0.041 0.189 (pd – s) < 0 r < Y^ Weak form sustainability

1986 0.060 −0.069 −0.001 0.129 (pd – s) < 0 r < Y^ Weak form sustainability

1987 0.055 −0.072 0.013 0.113 (pd – s) < 0 r > Y^ Unsustainable

1988 0.060 −0.068 −0.023 0.152 (pd – s) < 0 r < Y^ Weak form sustainability

1989 0.046 −0.059 −0.044 0.148 (pd – s) < 0 r < Y^ Weak form sustainability

1990 0.044 −0.049 −0.003 0.096 (pd – s) < 0 r < Y^ Weak form sustainability

1991 0.053 −0.082 −0.072 0.207 (pd – s) < 0 r < Y^ Weak form sustainability

1992 0.072 −0.072 −0.059 0.204 (pd – s) < 0 r < Y^ Weak form sustainability

1993 0.022 −0.074 0.007 0.089 (pd – s) < 0 r > Y^ Unsustainable

1994 0.043 −0.059 −0.032 0.134 (pd – s) < 0 r < Y^ Weak form sustainability

1995 0.040 −0.065 −0.035 0.140 (pd – s) < 0 r < Y^ Weak form sustainability

1996 0.062 −0.065 −0.034 0.161 (pd – s) < 0 r < Y^ Weak form sustainability

1997 0.017 −0.067 0.008 0.076 (pd – s) < 0 r > Y^ Unsustainable

1998 0.034 −0.072 0.038 0.068 (pd – s) < 0 r > Y^ Unsustainable

1999 0.040 −0.059 0.044 0.055 (pd – s) < 0 r > Y^ Unsustainable

2000 0.038 −0.073 0.057 0.054 (pd – s) < 0 r > Y^ Unsustainable

2001 0.019 −0.076 0.068 0.027 (pd – s) < 0 r > Y^ Unsustainable

2002 0.030 −0.079 0.062 0.047 (pd – s) < 0 r > Y^ Unsustainable

2003 0.045 −0.098 0.014 0.129 (pd – s) < 0 r > Y^ Unsustainable

2004 0.070 −0.099 −0.049 0.218 (pd – s) < 0 r < Y^ Weak form sustainability

2005 0.082 −0.122 −0.094 0.298 (pd – s) < 0 r < Y^ Weak form sustainability

2006 0.055 −0.127 −0.033 0.215 (pd – s) < 0 r < Y^ Weak form sustainability

2007 0.052 −0.148 −0.020 0.220 (pd – s) < 0 r < Y^ Weak form sustainability

2008 0.048 −0.198 −0.046 0.291 (pd – s) < 0 r < Y^ Weak form sustainability

2009 0.004 −0.178 −0.058 0.239 (pd – s) < 0 r < Y^ Weak form sustainability

2010 0.025 −0.209 −0.009 0.243 (pd – s) < 0 r < Y^ Weak form sustainability

2011 0.035 −0.242 −0.018 0.294 (pd – s) < 0 r < Y^ Weak form sustainability

2012 0.037 −0.254 −0.022 0.314 (pd – s) < 0 r < Y^ Weak form sustainability

2013 0.035 −0.295 −0.003 0.327 (pd – s) < 0 r < Y^ Weak form sustainability

2014 0.039 −0.289 −0.018 0.346 (pd – s) < 0 r < Y^ Weak form sustainability

2015 0.041 −0.298 −0.002 0.336 (pd – s) < 0 r < Y^ Weak form sustainability

2016 0.060 −0.307 −0.006 0.231 (pd – s) < 0 r < Y^ Weak form sustainability

Year	Change in Debt as % of GDP (Δb)	(pd – s)	(r – y^)	Residuals	Nature of (pd – s)	Nature of (r – Y^)	Nature of Public Debt
1971	0.000	−0.068	0.010	0.057	(pd – s) < 0	r > Y^	Unsustainable
1972	0.023	−0.071	0.015	0.079	(pd – s) < 0	r > Y^	Unsustainable
1973	0.064	−0.062	−0.079	0.204	(pd – s) < 0	r < Y^	Weak form sustainability
1974	0.069	−0.073	−0.232	0.375	(pd – s) < 0	r < Y^	Weak form sustainability
1975	0.037	−0.069	−0.164	0.270	(pd – s) < 0	r < Y^	Weak form sustainability
1976	0.032	−0.087	−0.039	0.158	(pd – s) < 0	r < Y^	Weak form sustainability
1977	0.028	−0.079	−0.029	0.136	(pd – s) < 0	r < Y^	Weak form sustainability
1978	0.072	−0.073	−0.040	0.185	(pd – s) < 0	r < Y^	Weak form sustainability
1979	0.052	−0.085	−0.008	0.145	(pd – s) < 0	r < Y^	Weak form sustainability
1980	0.068	−0.058	−0.070	0.197	(pd – s) < 0	r < Y^	Weak form sustainability
1981	0.060	−0.051	−0.074	0.186	(pd – s) < 0	r < Y^	Weak form sustainability
1982	0.070	−0.050	−0.079	0.199	(pd – s) < 0	r < Y^	Weak form sustainability
1983	0.064	−0.062	−0.012	0.138	(pd – s) < 0	r < Y^	Weak form sustainability
1984	0.038	−0.051	−0.007	0.096	(pd – s) < 0	r < Y^	Weak form sustainability
1985	0.080	−0.068	−0.041	0.189	(pd – s) < 0	r < Y^	Weak form sustainability
1986	0.060	−0.069	−0.001	0.129	(pd – s) < 0	r < Y^	Weak form sustainability
1987	0.055	−0.072	0.013	0.113	(pd – s) < 0	r > Y^	Unsustainable
1988	0.060	−0.068	−0.023	0.152	(pd – s) < 0	r < Y^	Weak form sustainability
1989	0.046	−0.059	−0.044	0.148	(pd – s) < 0	r < Y^	Weak form sustainability
1990	0.044	−0.049	−0.003	0.096	(pd – s) < 0	r < Y^	Weak form sustainability
1991	0.053	−0.082	−0.072	0.207	(pd – s) < 0	r < Y^	Weak form sustainability
1992	0.072	−0.072	−0.059	0.204	(pd – s) < 0	r < Y^	Weak form sustainability
1993	0.022	−0.074	0.007	0.089	(pd – s) < 0	r > Y^	Unsustainable
1994	0.043	−0.059	−0.032	0.134	(pd – s) < 0	r < Y^	Weak form sustainability
1995	0.040	−0.065	−0.035	0.140	(pd – s) < 0	r < Y^	Weak form sustainability
1996	0.062	−0.065	−0.034	0.161	(pd – s) < 0	r < Y^	Weak form sustainability
1997	0.017	−0.067	0.008	0.076	(pd – s) < 0	r > Y^	Unsustainable
1998	0.034	−0.072	0.038	0.068	(pd – s) < 0	r > Y^	Unsustainable
1999	0.040	−0.059	0.044	0.055	(pd – s) < 0	r > Y^	Unsustainable
2000	0.038	−0.073	0.057	0.054	(pd – s) < 0	r > Y^	Unsustainable
2001	0.019	−0.076	0.068	0.027	(pd – s) < 0	r > Y^	Unsustainable
2002	0.030	−0.079	0.062	0.047	(pd – s) < 0	r > Y^	Unsustainable
2003	0.045	−0.098	0.014	0.129	(pd – s) < 0	r > Y^	Unsustainable
2004	0.070	−0.099	−0.049	0.218	(pd – s) < 0	r < Y^	Weak form sustainability
2005	0.082	−0.122	−0.094	0.298	(pd – s) < 0	r < Y^	Weak form sustainability
2006	0.055	−0.127	−0.033	0.215	(pd – s) < 0	r < Y^	Weak form sustainability
2007	0.052	−0.148	−0.020	0.220	(pd – s) < 0	r < Y^	Weak form sustainability
2008	0.048	−0.198	−0.046	0.291	(pd – s) < 0	r < Y^	Weak form sustainability
2009	0.004	−0.178	−0.058	0.239	(pd – s) < 0	r < Y^	Weak form sustainability
2010	0.025	−0.209	−0.009	0.243	(pd – s) < 0	r < Y^	Weak form sustainability
2011	0.035	−0.242	−0.018	0.294	(pd – s) < 0	r < Y^	Weak form sustainability
2012	0.037	−0.254	−0.022	0.314	(pd – s) < 0	r < Y^	Weak form sustainability
2013	0.035	−0.295	−0.003	0.327	(pd – s) < 0	r < Y^	Weak form sustainability
2014	0.039	−0.289	−0.018	0.346	(pd – s) < 0	r < Y^	Weak form sustainability
2015	0.041	−0.298	−0.002	0.336	(pd – s) < 0	r < Y^	Weak form sustainability
2016	0.060	−0.307	−0.006	0.231	(pd – s) < 0	r < Y^	Weak form sustainability

Source: The authors.

Notes: (i) pd – s must be greater than zero if less than zero then it is an indicator of the unsustainable nature of public debt.

(ii) r must be less than Y^ otherwise, it indicates the unsustainable nature of debt.

The role of interest rate—growth rate differential is evident from the studies of (Bilquees, 2003; Ejaz & Javid, 2011; Ley, 2009; Rangarajan & Srivastava, 2003) while making sustainability assessment of public debt burden. The existing literature suggests that if interest rate–growth rate differential come up with the negative sign, it implies that the differential is not contributing towards debt accumulation or indebtedness. The negative estimates suggest that differential has tried to play its possible role to decelerate the increase of debt-to-GDP ratio in Pakistan.

The overall dynamics of the public debt of Pakistan indicates that increase in debt-to-GDP ratio has its roots in primary imbalances of past. The slow growth rate in revenue and resource mobilization, consistently increasing government spending, increasing imports payments, and slow and stagnant growth of exports have played their role in substantial primary imbalances. The use of different IMF packages and implementation of structural adjustment programs in the 1990s, 2000s and afterward that include liberalization policies, privatization deregulation, and so on could not rectify the fiscal and current account imbalances. Instead, the structural reform programmes raised the cost of borrowing sharply. The whole situation brought a shift towards a market-based system of raising public debt, which raised the interest rates on domestic borrowing. The reforms process did not bring any significant change in the growth of exports; instead, imports grew sharply that caused current account imbalances. As a result, the burden of public debt continued to increase towards unsustainable levels.

The three factors attributed the alarming growth in public debt during the past decades, that is, first, deteriorated and slow increase in government revenues was one of the critical reasons that caused high growth in public debt burden. Furthermore, an improvement in the real growth of revenues was experienced in the year 2000 but again turned negative in 2003 and 2005; the situation remained unchanged. Second, the real cost of borrowing rose to 5.3 per cent in the second half of the 1980s and reached the minimum level of 2 per cent in the first half of the 1990s. Subsequently, it increased on average to 4.5 and 4 per cent in the second half of the 1990s and 2000s, respectively. The real debt rose because of two main reasons in the 1980s and 1990s. First, before the financial sector reforms in 1989, interest rates were controlled, and the government could borrow at significantly below-market rates. Second, a substantial portion of the public debt raised during the 1980s was through the National Savings Schemes.

Now consider the second factor that has potential to affect debt ratio, that is, a differential of primary budget balance and change of reserve money-to-GDP ratio. The estimates of the said factor are showing that the primary budget balance is negative, that is, in deficit and playing an active role in increasing the debt ratio. However, for a few years, that is, 2001–2010, the estimates have negative values, but this negative effect was very minimal. The estimated results suggest that primary budget balance (deficit) has a played vital role in the acceleration of public debt burden of Pakistan.

A rationale behind fiscal stability and debt sustainability is that debt ratio will be increased interestingly if the real interest rate exceeds GDP growth rate of an economy. If the interest rate remained below the growth rate of the economy, the continuous primary budget deficits would lead towards indebtedness. The large primary budget deficits tend to increase debt ratio to such a high level that primary budget surplus becomes compulsory for the maintenance of long-term sustainability of debt-to-GDP ratio (Bilquees 2003; Rangarajan & Srivastara, 2003). The scenario is the same in case of Pakistan, as the estimates of primary budget balance-to-GDP ratio and reserve money-to-GDP ratio differential are having a negative sign which means the unsustainable nature of debt stock due to primary budget balance, that is, the deficit.

The graphical representations of the different factors that affected the debt-to-GDP of Pakistan in the past are given in Figures 1–4.

The framework for the assessment of dynamics of external debt burden indicates that external debt-to-export ratio is always influenced and affected by the growth of exports, ratio current account balance-to-exports and interest rate on public debt. During the period 1971–2017, the external debt-to-export ratio of Pakistan remained between the levels of 1.7 and 5.5. If one looks at the changes in external debt-to-export ratio, it will become clear that change in external debt as a percentage of exports ranges from 0.5 per cent to 54 per cent, and estimates are positive for most of the years. Except for 17 years for which the change was negative. The estimates suggest that external debt as a percentage of exports has shown an increasing trend over the years. This study explains the two components which have influenced change in the external debt-to-exports ratio over the period of 1971–2017. One is current account balance-to-exports ratio, and another is the differential of exports growth and dollar interest rate. The negative estimates of the current account balance-to-export ratio for most of the years during 1971–2017 shows that current account was in deficit except for just 4 years, that is, 2003, 2004 and 2011 during the period 1971–2017. This ratio of current account balance-to-export has been found exerting strong positive impact towards the acceleration of changing external debt-to-export ratio, and this strong impact was due to the continuing deficits in the current account. This increasing and the positive trend of current account deficit-to-exports ratio indicate an unsustainable scenario of the external debt burden of Pakistan. The differential of export growth and the interest rate is showing the positive estimates for all the years thus exerting a positive pressure towards the increase of external debt. These positive natures of differentials tell us that the nature of the external debt burden is unsustainable. The detailed analysis of external debt sustainability is presented in Table 2.

Table 2.

External Debt Sustainability Analysis for Pakistan

Year	Δe	Current Account Balance to the Export Ratio (z)	(g – i*)	Residuals	Nature of (z)	Nature of (g – i*)	Nature of External Debt
1971		−0.836			z < 0
1972		−0.839	−0.117		z < 0	g < i*	Unsustainable
1973		−0.352	0.180		z < 0	g > i*	Weak form sustainability
1974		−0.681	0.168		z < 0	g > i*	Weak form sustainability
1975		−1.345	−0.066		z < 0	g < i*	Unsustainable
1976	4.220	−1.143	0.026	6.643	z < 0	g > i*	Weak form sustainability
1977	5.127	−1.439	−0.065	3.007	z < 0	g < i*	Unsustainable
1978	−0.503	−1.393	0.059	4.093	z < 0	g > i*	Weak form sustainability
1979	−9.410	−1.526	0.177	0.121	z < 0	g > i*	Weak form sustainability
1980	−8.664	−1.284	0.231	1.033	z < 0	g > i*	Weak form sustainability
1981	−7.127	−1.104	0.062	−4.203	z < 0	g > i*	Weak form sustainability
1982	15.971	−1.585	−0.307	3.640	z < 0	g < i*	Unsustainable
1983	0.790	−1.325	−0.019	1.239	z < 0	g < i*	Unsustainable
1984	5.754	−1.459	−0.099	2.085	z < 0	g < i*	Unsustainable
1985	10.254	−1.744	−0.195	−0.120	z < 0	g < i*	Unsustainable
1986	−0.648	−1.321	0.144	9.513	z < 0	g > i*	Weak form sustainability
1987	−4.459	−0.888	0.118	3.165	z < 0	g > i*	Weak form sustainability
1988	−2.765	−0.884	0.115	4.385	z < 0	g > i*	Weak form sustainability
1989	10.552	−0.860	−0.056	7.796	z < 0	g < i*	Unsustainable
1990	2.203	−0.826	−0.042	0.198	z < 0	g < i*	Unsustainable
1991	−4.253	−0.693	0.158	6.327	z < 0	g > i*	Weak form sustainability
1992	2.404	−0.645	0.058	6.850	z < 0	g > i*	Weak form sustainability
1993	20.125	−0.882	−0.073	14.743	z < 0	g < i*	Unsustainable
1994	7.952	−0.639	−0.072	1.847	z < 0	g < i*	Unsustainable
1995	0.700	−0.605	0.106	11.273	z < 0	g > i*	Weak form sustainability
1996	9.836	−0.799	−0.013	9.319	z < 0	g < i*	Unsustainable
1997	19.916	−0.818	−0.129	4.797	z < 0	g < i*	Unsustainable
1998	−0.714	−0.595	−0.047	−5.850	z < 0	g < i*	Unsustainable
1999	54.916	−0.605	−0.178	23.805	z < 0	g < i*	Unsustainable
2000	2.052	−0.491	0.009	4.186	z < 0	g > i*	Weak form sustainability
2001	−2.406	−0.479	0.005	−1.100	z < 0	g > i*	Weak form sustainability
2002	0.065	−0.319	−0.054	−9.213	z < 0	g < i*	Unsustainable
2003	−31.103	0.365	0.181	−5.020	z > 0	g > i*	Sustainable
2004	−7.001	0.147	0.060	1.212	z > 0	g > i*	Sustainable
2005	−16.367	−0.107	0.107	−3.103	z < 0	g > i*	Weak form sustainability
2006	−9.240	−0.303	0.064	−1.696	z < 0	g > i*	Weak form sustainability
2007	3.407	−0.405	−0.049	−1.887	z < 0	g < i*	Unsustainable
2008	38.182	−0.728	0.071	50.016	z < 0	g > i*	Weak form sustainability
2009	34.077	−0.524	−0.104	14.865	z < 0	g < i*	Unsustainable
2010	−6.128	−0.205	0.058	4.729	z < 0	g > i*	Weak form sustainability
2011	−22.415	0.009	0.254	18.421	z > 0	g > i*	Sustainable
2012	22.837	−0.197	−0.080	8.270	z < 0	g < i*	Unsustainable
2013	2.960	−0.102	0.003	3.609	z < 0	g > i*	Weak form sustainability
2014	−5.086	−0.125	−0.006	−6.046	z < 0	g < i*	Unsustainable
2015	4.122	−0.114	−0.090	−12.502	z < 0	g < i*	Unsustainable
2016	4.999	−0.132	0.093	5.897	z < 0	g > i*	Weak form sustainability

Source: The authors.

Notes: (i) z > 0 is the benchmark for external debt sustainability.

(ii) g > i* is the benchmark for debt sustainability.

The graphical representations of the change in external debt as percentage of exports, interest rate–exports growth differential, current account balance-to-exports ratio and residuals are given in Figures 5–8, respectively.

The Case of India

The results for India have been estimated in the study show that the debt-to-GDP ratio has been showing a mixed trend since 1971. The variations in the debt-to-GDP ratio are positive (an increasing trend) for some years while negative (a decreasing trend) for other years. In 1971, the increase in debt as a percentage of GDP was just 1.7 per cent, which has increased to 3.8 per cent of GDP in 1981 and afterward increased to 3.83 per cent of GDP in 1991. The change (increase) in the debt-to-GDP ratio was 4.08 per cent in 2001, and this change of debt-to-GDP ratio decreased to −4.11 per cent in 2011 and 0.8 per cent in 2016. This change in debt-to-GDP ratio indicates an intensity of changing (increasing) debt burden over the number of years.

Though some of the year in the analysis have the low, increasing intensity of debt-to-GDP ratio, there are also some years in the history of India in which debt as a percentage of GDP has decreased. For all the year in the analysis, debt as a percentage of GDP is showing a positively increasing trend for some years, and growth of debt as a percentage of GDP is negative in India in some years over the period of analysis. This increasing trend is showing the rate of indebtedness or accumulation of debt in India, which means that the debt burden of India has been increasing since 1971.

The two factors that have the potential to affect debt-to-GDP ratio include interest rate–growth differential and primary budget balance–reserve money ratio differential. The estimates of interest rate–growth rate differential have negative values for most of the years, which indicate that it has not played any role in the increase of public debt of India. The interest rate–growth rate differential showed mixed estimates as the differential has increased in some years while decreased in other years, but the ultimate effect of interest rate and growth rate is negative. This interest rate–growth rate differential represents that real interest rate in India has been under the control of Indian government for most of the years and thus remained below the growth rate of Indian economy. The public debt sustainability analysis for India is presented in Table 3.

Table 3.

Public Debt Sustainability Analysis for India

Year	Change in Debt as % of GDP (Δb)	(pd – s)	(r – y^)	Residuals	Nature of (pd – s)	Nature of (r – Y^)	Nature of Public Debt
1971		−0.100			(pd – s) < 0
1972	0.017	−0.101			(pd – s) < 0
1973	0.005	−0.102			(pd – s) < 0
1974	0.011	−0.090			(pd – s) < 0
1975	0.007	−0.086			(pd – s) < 0
1976	0.011	−0.102			(pd – s) < 0
1977	0.007	−0.097			(pd – s) < 0
1978	0.015	−0.121	0.051	0.116	(pd – s) < 0	r > Y^	Unsustainable
1979	0.010	−0.127	0.042	0.120	(pd – s) < 0	r > Y^	Unsustainable
1980	0.009	−0.113	−0.023	0.132	(pd – s) < 0	r < Y^	Weak form sustainability
1981	0.004	−0.111	−0.009	0.118	(pd – s) < 0	r < Y^	Weak form sustainability
1982	0.047	−0.104	0.043	0.131	(pd – s) < 0	r > Y^	Unsustainable
1983	−0.010	−0.114	0.000	0.104	(pd – s) < 0	r > Y^	Unsustainable
1984	0.026	−0.115	0.041	0.121	(pd – s) < 0	r > Y^	Unsustainable
1985	0.043	−0.109	0.034	0.133	(pd – s) < 0	r > Y^	Unsustainable
1986	0.041	−0.112	0.043	0.129	(pd – s) < 0	r > Y^	Unsustainable
1987	0.031	−0.126	0.026	0.141	(pd – s) < 0	r > Y^	Unsustainable
1988	−0.004	−0.128	−0.020	0.135	(pd – s) < 0	r < Y^	Weak form sustainability
1989	0.019	−0.141	0.015	0.151	(pd – s) < 0	r > Y^	Unsustainable
1990	−0.013	−0.134	−0.003	0.123	(pd – s) < 0	r < Y^	Weak form sustainability
1991	0.038	−0.149	0.026	0.171	(pd – s) < 0	r > Y^	Unsustainable
1992	−0.014	−0.142	0.037	0.106	(pd – s) < 0	r > Y^	Unsustainable
1993	0.006	−0.142	0.011	0.142	(pd – s) < 0	r > Y^	Unsustainable
1994	−0.024	−0.166	−0.023	0.156	(pd – s) < 0	r < Y^	Weak form sustainability
1995	−0.029	−0.165	−0.017	0.146	(pd – s) < 0	r < Y^	Weak form sustainability
1996	−0.030	−0.147	0.002	0.116	(pd – s) < 0	r > Y^	Unsustainable
1997	0.019	−0.142	0.029	0.145	(pd – s) < 0	r > Y^	Unsustainable
1998	−0.001	−0.138	−0.011	0.143	(pd – s) < 0	r < Y^	Weak form sustainability
1999	0.007	−0.134	0.003	0.139	(pd – s) < 0	r > Y^	Unsustainable
2000	0.026	−0.133	0.045	0.131	(pd – s) < 0	r > Y^	Unsustainable
2001	0.041	−0.134	0.038	0.151	(pd – s) < 0	r > Y^	Unsustainable
2002	0.034	−0.136	0.041	0.143	(pd – s) < 0	r > Y^	Unsustainable
2003	−0.009	−0.156	−0.006	0.151	(pd – s) < 0	r < Y^	Weak form sustainability
2004	−0.005	−0.155	−0.030	0.170	(pd – s) < 0	r < Y^	Weak form sustainability
2005	−0.016	−0.159	−0.030	0.162	(pd – s) < 0	r < Y^	Weak form sustainability
2006	−0.025	−0.174	−0.048	0.178	(pd – s) < 0	r < Y^	Weak form sustainability
2007	0.000	−0.208	0.004	0.206	(pd – s) < 0	r > Y^	Unsustainable
2008	−0.025	−0.158	0.004	0.131	(pd – s) < 0	r > Y^	Unsustainable
2009	−0.002	−0.155	−0.027	0.169	(pd – s) < 0	r < Y^	Weak form sustainability
2010	−0.023	−0.171	−0.109	0.209	(pd – s) < 0	r < Y^	Weak form sustainability
2011	−0.041	−0.146	−0.051	0.132	(pd – s) < 0	r < Y^	Weak form sustainability
2012	0.013	−0.145	−0.030	0.174	(pd – s) < 0	r < Y^	Weak form sustainability
2013	−0.010	−0.154	−0.025	0.158	(pd – s) < 0	r < Y^	Weak form sustainability
2014	−0.005	−0.159	−0.004	0.156	(pd – s) < 0	r < Y^	Weak form sustainability
2015	−0.006	−0.170	0.000	0.163	(pd – s) < 0	r > Y^	Unsustainable
2016	0.008	−0.174	−0.030	0.172	(pd – s) < 0	r < Y^	Weak form sustainability

Source: The authors.

Notes: (i) x – s must be greater than zero if less than zero then it is an indicator of the unsustainable nature of public debt.

(ii) r must be less than Y^ otherwise, it indicates the unsustainable nature of debt.

In the analysis of the accumulation of the debt, two factors are identified as contributing to the debt-GDP ratio. One is the cumulated primary deficits and the other is the cumulated effect of the difference between growth rate and interest rate. Throughout 45 years from 1955–1956 to 1999–2000, the real growth rate was more than the real interest rate. So, for very few years, the real growth rate has been less than the real interest rate. During the 1990s, even when the GDP growth rate remained more than the interest rate, the gap between the two has been narrowing. If the days of large positive differences between growth and interest rates are all but over, there are severe implications for strategies aimed at containing the growth of debt relative to GDP. India is entering into an era, where corrections in the primary balance profile of the central government have become imperative.

If the reversal in the sign of the difference in interest rate and growth rate is sustained, rather than partially absorbing the impact of the cumulated primary deficit, it will add to the accumulation of debt. Even if the difference in interest rate and growth rate turns out to be positive, it is likely that the days of a large excess of growth rate over interest rate are over. Therefore, the likelihood of primary deficits getting converted into a rise in the debt-to-GDP ratio is stronger now. It may also be noted that the effective interest rate for the central government is lower than the corresponding effective rate for the states. The adverse impact of the changes in the difference in interest rate and growth rate for the states would, therefore, be even stronger. The primary deficit is the excess of primary expenditure, that is, total expenditure minus interest payments over revenue receipts capacity to adjust to changes in the relativity of growth and interest rates is limited. The economy of India indicates that the primary deficit-to-GDP ratio is less volatile and more autonomous than the difference in interest rate and growth rate.

The graphical representations of different factors that affected the debt-to-GDP of Pakistan in the past are given in Figures 9–12.

The results of the equation for assessment of dynamics of external debt burden reveals that during the period 1971–2017, the external debt-to-export ratio of India remained between the levels of −0.04 and 7.30. If one looks at the changes in external debt-to-export ratio, it will become clear that change in external debt as a percentage of exports ranges from −4 per cent to 80 per cent, and estimates are negative for most of the years. The estimates suggest us that external debt as a percentage of exports have shown a mixed (decreasing in some years and increasing in some years) trend over the years. This study explains the two components, which have influenced change in the external debt-to-exports ratio over the period of 1971–2017. One is current account balance-to-exports ratio, and another is the differential of exports growth and dollar interest rate. The negative estimates of the current account balance-to-export ratio for most of the years during 1971–2017 are showing that the current account was in deficit except for just a few years during the period 1971–2017. This ratio of current account balance-to-export has been found exerting strong positive impact towards the acceleration of changing external debt-to-export ratio, and this strong impact was due to the continuing deficits in the current account. These increasing trends of current account deficit-to-exports ratio tell us an unsustainable scenario of the external debt burden of India. The differential of export growth and the interest rate is showing the positive estimates for some of the years thus exerting a negative pressure towards the increase of external debt. These positive natures of differentials tell us that the nature of the external debt burden is sustainable. The results for sustainability analysis of external debt burden of India are given in Table 4.

Table 4.

External Debt Sustainability Analysis for India

Year	Δe	Current Account Balance to Export Ratio (z)	(g – i*)	Residuals	Nature of (z)	Nature of (g – i*)	Nature of External Debt
1971
1972
1973
1974
1975
1976
1977	0.208	0.039
1978	−0.042	0.012	−0.098	−0.399	z > 0	g < i*	Weak form sustainability
1979	0.062	0.001	−0.015	0.010	z > 0	g < i*	Weak form sustainability
1980	−0.290	−0.027	−0.141	−0.762	z < 0	g < i*	Unsustainable
1981	0.234	−0.035	0.094	0.574	z < 0	g > i*	Weak form sustainability
1982	−0.205	−0.029	0.083	0.111	z < 0	g > i*	Weak form sustainability
1983	−0.079	−0.020	0.078	0.194	z < 0	g > i*	Weak form sustainability
1984	0.396	−0.020	0.227	1.141	z < 0	g > i*	Weak form sustainability
1985	−0.786	−0.038	−0.090	−1.072	z < 0	g < i*	Unsustainable
1986	−0.026	−0.037	0.082	0.240	z < 0	g > i*	Weak form sustainability
1987	0.161	−0.033	0.212	0.781	z < 0	g > i*	Weak form sustainability
1988	0.479	−0.035	0.293	1.374	z < 0	g > i*	Weak form sustainability
1989	0.339	−0.025	0.485	2.019	z < 0	g > i*	Weak form sustainability
1990	0.149	−0.022	0.170	0.807	z < 0	g > i*	Weak form sustainability
1991	1.290	−0.010	0.669	3.910	z < 0	g > i*	Weak form sustainability
1992	0.926	−0.008	0.330	2.648	z < 0	g > i*	Weak form sustainability
1993	1.521	−0.003	0.516	4.680	z < 0	g > i*	Weak form sustainability
1994	0.808	−0.002	0.111	1.659	z < 0	g > i*	Weak form sustainability
1995	2.892	−0.005	0.241	4.934	z < 0	g > i*	Weak form sustainability
1996	1.307	−0.005	0.138	2.878	z < 0	g > i*	Weak form sustainability
1997	1.187	−0.002	0.038	1.671	z < 0	g > i*	Weak form sustainability
1998	0.380	−0.005	0.137	2.280	z < 0	g > i*	Weak form sustainability
1999	1.779	−0.002	0.111	3.360	z < 0	g > i*	Weak form sustainability
2000	4.138	−0.002	0.240	7.971	z < 0	g > i*	Weak form sustainability
2001	0.877	0.001	0.009	1.055	z > 0	g > i*	Sustainable
2002	3.122	0.003	0.210	7.540	z > 0	g > i*	Sustainable
2003	0.548	0.003	0.061	2.014	z > 0	g > i*	Sustainable
2004	5.680	0.000	0.201	10.646	z > 0	g > i*	Sustainable
2005	7.303	−0.002	0.121	10.993	z < 0	g > i*	Weak form sustainability
2006	−1.817	−0.002	0.207	5.998	z < 0	g > i*	Weak form sustainability
2007	−3.701	−0.001	−0.034	−4.907	z < 0	g < i*	Unsustainable
2008	4.878	−0.004	0.298	14.456	z < 0	g > i*	Weak form sustainability
2009	−4.031	−0.003	0.086	−0.827	z < 0	g > i*	Weak form sustainability
2010	6.365	−0.005	0.244	14.432	z < 0	g > i*	Weak form sustainability
2011	4.485	−0.004	0.277	15.378	z < 0	g > i*	Weak form sustainability
2012	−2.213	−0.006	0.244	8.487	z < 0	g > i*	Weak form sustainability
2013	2.957	−0.003	0.246	13.187	z < 0	g > i*	Weak form sustainability
2014	−3.135	−0.001	0.004	−2.941	z < 0	g > i*	Weak form sustainability
2015	−5.698	−0.001	−0.082	−9.109	z < 0	g < i*	Unsustainable
2016	1.208	0.000	0.185	7.114	z < 0	g > i*	Weak form sustainability

Source: The authors.

Notes: z > 0 is the benchmark for external debt sustainability.

g > i* is the benchmark for debt sustainability.

VI. Conclusion and Policy Implications

The current study for assessment of debt sustainability indicates that growth rate of GDP, interest rate, primary budget balance and changing nature of reserve money have a combined role in overall indebtedness of Pakistan and India. The interest rate–growth rate differential has not positively influenced the growth of public debt rather differential effect is negative. On the other hand, the primary budget balance has a significant positive involvement in the mounting debt burden of Pakistan and India. The dynamics of external debt show that high CADs and low growth rate of exports have played their part in making external debt unsustainable over the period 1971–2017. The study has concluded that the positive contribution of primary budget balance (deficit), current account balance (deficit) and low growth of exports have played their part in increasing the debt level of Pakistan and India and weak form of sustainability. Though India is one of the fastest growing economies of the world, and Pakistan is developing the country, but conditions of indebtedness and debt sustainability are almost the same regardless of the growth and volume of these two economies.

Several policy implications emerge from this study which could be relevant for Pakistan and India, ensuring debt sustainability. It is crucial to control interest rate at such a level so that it remains below the growth rate of these economies as done in the past. The reduction in primary budget deficits is required, which can be done through rationalization of government expenditures as the primary balance has been found positively influencing in the accumulation of public debt in these two countries. There should be concrete steps to promote exports as the growth of exports is quite low and has continuously positively affecting external debt. The coordination is required between fiscal policy and monetary policy so that the primary budget balance could be reduced in these countries.

Moreover, it is also worthy to mention and seek guidance from the recommendations suggested by the recent study of Chandia et al. (2018). The work of Chandia et al. (2018) has recommended the need for extensive fiscal policy reforms for the control of budget deficits. The budget deficit in case of both Pakistan and India cannot be reduced without reforms process. Fiscal authorities need to increase the tax base by increasing direct taxes instead of imposing indirect taxes on poor people of the country for wasteful government spending. For case of Pakistan, the situation of exports is far below the optimal level and CAD can only be reduced by giving special attention for boosting exports of Pakistan.

Declaration of Conflicting Interests

The authors declared no potential conflicts of interest with respect to the research, authorship and/or publication of this article.

Funding

The authors received no financial support for the research, authorship and/or publication of this article.

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