The Sunday Times Economic Analysis

The Sunday Times Economic Analysis By the Economist

The debt trap: The ever increasing public debt

The annual cost of servicing the public debt were higher than government revenue last year. In 2002 government revenue was Rs. 261 billion, the debt servicing costs were Rs.284 billion.

This is a precarious situation. As a nation we have become like an indebted family whose debt repayments and interest charges exceed the household income. In such a predicament the head of the household is likely to commit suicide.

Not so for a government or country. A nation can survive by continuing to borrow. The implications for the nation's economy, however, are serious.

Future prospects for the economy are being jeopardised by the debt burden that is continuing to grow. At the end of June this year the public debt had increased to Rs. 1750 billion an amount higher than our current national income. This was about a 5 per cent increase from that of the end of last year and about 11 per cent higher than a year ago.

In 2002 the public debt was 105 per cent of the Gross Domestic Product (GDP) while in the previous year (2001) for the first time it increased above the GDP to 104 per cent of GDP.

Debt service payments exceeded government revenue for the first time last year. This is likely to persist this year too especially as government revenue collections have fallen short of expectations.

The public debt has two components: the domestic debt and the foreign debt. The domestic debt is the larger component accounting for about 55 per cent of the total debt. Both components have been increasing though the relative proportions have remained around the same.

The increase in the foreign debt in recent years has been mainly owing to the depreciation of the Rupee.

When the amount of the foreign debt is designated in rupees it increases owing to the depreciation of the rupee. The Central Bank has pointed out that the cumulative increase in the foreign debt has been as much as Rs. 251 billion in the past six years owing to the depreciation of the currency alone.

This is over one-third the total foreign debt. The foreign debt that was Rs. 461 billion in 1998; had risen to Rs. 721 billion at the end of last year and to Rs.759 billion at the end of June this year.

The domestic debt that was Rs 463 billion at the end of 1998 rose to Rs 948 billion at the end of last year and to Rs. 991 billion at the end of June.

The foreign debt is not looked upon as much of a burden as the conventional way of looking at its burden is the servicing cost in terms of export earnings. This foreign debt-servicing ratio has been quite modest.

The foreign debt servicing costs, as a proportion of our export earnings was the highest last year, when it reached 8.3 per cent of export earnings. Between 1998 and 2002 it ranged between 6 to 8 per cent. Although the foreign debt has increased this year the debt servicing ratio is likely to decline as our export earnings this year are rising by a larger amount.

The foreign debt service ratio is a manageable amount in relation to our export incomes. Yet it must be remembered that the foreign debt is an important component of the total debt and its increase adds to the unbearable debt burden of the country.

The implication of the high costs of servicing the debt is that the government does not have resources for vital current as well as capital expenditure. Consequently it has to either borrow or seek foreign assistance.

In either case the debt continues to grow and its servicing continues to be a serious burden. The debt trap is a vicious cycle from which the country could extricate itself only by higher selective taxation, better collection of taxes, reduction in wasteful expenditure and through higher rates of economic growth. Successive governments have failed in their efforts to reduce budget deficits and consequently the debt has increased. Unfortunately there is no perceptible assurance of a reduced debt in the foreseeable future.

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