The Behavior Of Public Finance Imbalances As An Explanation For Macroeconomic De-stabilization And The Need For Fiscal Policy Reforms

The current dissertation has analyzed imbalances in public finance structure of the economy of Pakistan and highlights the need comprehensive reforms in fiscal structure of Pakistan.More specially,the study has contributed to empirical literature by analyzing four different issues which include the interaction between fiscal vulnerability,financial stress and macroeconomic policies,sustainability of public debt burden,debt overhang hypothesis and determinants of debt rescheduling capacity in the economy of Pakistan for period 1971-201 8.The deteriorating patterns in fiscal dynamics of Pakistan have pointed out serious concerns and doubts for the sustainability of public finances in the medium-and long-run economic prospects.The first part of this dissertation has constructed/developed an index of fiscal vulnerability,an index of financial stress and a macroeconomic policies index.The fiscal vulnerability index is based on the patterns of fiscal indicators resulting from past trends of the selected variables in case of Pakistan's economy.The phenomenon of financial stress for the case of Pakistan is based on the events of financial disorders that have been acknowledged in the composite index which is based on the variables that have potential to indicate periods of stress stemming from foreign exchange market,securities market and the components of monetary policy.The macroeconomic policies index is developed to analyze the mechanism through which fiscal vulnerability and financial stress have influenced macroeconomic policies in Pakistan.The analysis of causal association between fiscal vulnerability,financial stress and macroeconomic policies has been carried out through Auto-Regressive Distributive Lags(ARDL)approach and results indicate an existence between the three indices and bi-directional causality between fiscal vulnerability and macroeconomic policies,i.e.,both cause and affect each other in Pakistan.The second part of current dissertation has employed a model for assessment of debt sustainability in economy of Pakistan.The model is derived from the major indicators that influence the dynamics of public debt such as output gap,government spending and primary budget balance.Additionally,the study has emphasized on the importance of some macroeconomics variables;which have been included and embedded in the model through fiscal vulnerability index and fiscal stress index as the potential determinants of primary budget balance.The model considers the reaction of the government,through fiscal reaction function,towards rising debt ratio and primary budget deficit.The empirical model has incorporated an index of fiscal vulnerability and an index financial stress in fiscal reaction functions for the case of Pakistan.The dummy for war on terror has also been included in the fiscal reaction functions to capture the consequences of 1.5 decades long war on terror,on the economy of Pakistan.The results indicate the weak form of sustainability of debt burden of Pakistan.The results support that war on terror has badly influenced fiscal indicators of Pakistan.Moreover,for the analysis of the macroeconomic effects of government spending and government revenue variations,the systematic relationship between government spending,government revenues and macroeconomic variables has been estimated by an unrestricted Vector Auto-Regression(VAR)approach about how government spending and government revenue innovations are transmitted to growth rate of gross domestic product,exchange rate,interest rate and public debt-to-GDP ratio.The Vector Auto-Regression(VAR)approach permits to classify how the government expenditure shock and government revenue shock influence various macroeconomic series by estimating the impulse response functions and variance decomposition.The findings of this part of dissertation advocate that in case of the economy of Pakistan,the variations are mostly explained by public debt-to-GDP ratio signifying that with upsurge in government expenditures that are funded through loans and liabilities raise the demand for domestic credit,thus increasing the interest rates.The households might foresee an upcoming increase in indirect taxes if government expenditures are is financed through loans and liabilities.The high government expenditures have led the deterioration of economy and the declining effect of output.The third part of present dissertation has presented an empirical analysis of the linkages between debt level,level of investment,human capital development and economic performance in context of the economy of Pakistan.The levels of public debt burden have remarkably risen as a result of the recent great recession and debt crisis,in developing as well as advanced countries.The academicians and policymakers have emphasized on the need of investigating the relationship between public debt and economic performance.The analysis on this issue is an effort to highlight various avenues through which heavy debt burden and its servicing costs have influenced economic growth of Pakistan and results provide the evidence in support of different hypotheses such as debt overhang hypothesis,crowding out effect and import compression effect.The Auto-Regressive Distributive Lags(ARDL)approach has been used for estimating different specification of an investment equation,a human capital equation and a growth equation.There are two major innovations in this part.One major innovation is the investigation of the association between human capital development,growth,and debt burden.Another innovation is the focus of this study towards the influence of debt and its servicing expense on growth via its impact on investment.To the best of my knowledge,no study has empirically tested the theoretical concepts such as debt overhang hypothesis,crowding out effect and import compression effect in the context of Pakistan.The last part of this dissertation is devoted towards analyzing and examining the determinants of debt rescheduling in Pakistan.The purpose behind the inclusion of this issue(debt rescheduling capacity)in current dissertation is to empirically analyze the causes behind the inability of the economy of Pakistan to fulfill the servicing obligations of its external debt burden.The current dissertation has restricted its attention to the economy of Pakistan.Pakistan occupies a unique significance to couple of developed countries of this globe.The geographical location,political instability,adoption of different economic policies in different decades,its bilateral ties with United States(US),China and middle east and its role in cold war and war against terror is inseparably linked with the economic conditions of Pakistan and its people.During the 1980s,1990s and 2000s,many developing economies including Pakistan have struggled hard for servicing of their external debt burden.The empirical analysis of this concept is a valuable addition towards the body of knowledge as there is no empirical evidence/empirical testing of the theory on this concept in literature in case of developing countries and specifically Pakistan.For measuring the probabilities and prospects of difficulties and challenges associated with debt servicing in Pakistan,this part of dissertation has estimated the parameters by employing a probit model.The results of empirical analysis suggest that the interest payments and overall debt servicing-to-exports ratio,the per capita income,the output growth and the reserves-to-imports ratio are the primary factors which have created problems and challenges for economy of Pakistan in servicing of its foreign debt obligations,and these concerns require special attention.The highlights the need for extensive structural reforms in public finance structure as the revenue and expenditure patterns and debt burden have deteriorated the economic conditions of Pakistan.