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Pakistan’s economic situation is deceptively sounder than it actually is. It’s public debt is about 50 per cent of GDP. Its external debt is about a quarter of GDP. And it basically told the IMF that it doesn’t need the last $ 3.7 billion tranche of an emergency loan that it had negotiated with the multilateral financial body.

Dig a bit deeper and you realize why Pakistan keeps running to the US, China, Saudi Arabia and, arguably, is now even interested in trade with India.

Islamabad has a debt problem not in turns of the amount of debt. Its problem lies in its ability to pay for its debt and a political system of entrenched interests – feudal landlords, the military and so on – who soak their government for everything they can.

Since its debt keeps rising but its tax revenues remain relatively stagnant, interest payments on its domestic debt have risen from 18.8 per cent of total revenue to 27.9 percent between 2005-06 to 2009-10. The situation is even worse when its measured as a percentage of tax revenue – 25.2 per cent to 38.6 per cent.

Anyone from India who goes to Pakistan will find the Indian rupee is almost double the value of its Pakistani counterpart. This reflects the fact that Pakistan is perpetually devaluing its currency. This adds to the burden of its debt. The economist Ashok Desai recently wrote that 20 per cent of the increase in Pakistan’s debt was due to a devaluing rupee. Between 2005-06 and 2010-11, the Pakistani rupee went from 59.8 to the dollar to 85.59. Even against the Chinese yuan its fallen from 7.4 to nearly 13.

This is perhaps no surprise given that the government has had to effectively print money to cover not only its defict, but also the fact that its terror-affected polity makes long-term government financing extremely difficult.

In 2003-04 the Pakistan government issued Rs 216 billion worth of three-month Market Related Treasury Bills and Rs 476 billion worth of similar one-year securities. In the first nine months of 2011, three month securities issues had ballooned to Rs 2.479 trillion while one-year ones were about the same at Rs 437 billion.

These bills are not only increasingly short-term, they are actually not market-related at all. They are simply sold to the central bank, the State Bank of Pakistan. Over a quarter of government debt financing is done through this method. Pakistan is, in effect, issuing short-term debt to itself. This is simply covering your bills by printing money.

Pakistan often argues its governmental finances are a mess because it has the burden of fighting the war against terror. Well, if it took that seriously it would also do what most war economies do which is tax their populations to cover the extra expenses.

But no one is peddling “Liberty Bonds” or something similar. Quite the opposite, Pakistan’s elite has fought tooth and nail all attempts at tax reform and expanding the government’s fiscal base. Which is a key reason for Pakistan’s falling out with the IMF – tax reforms is a key conditionality for the loan and Islamabad didn’t have the strength to push them through.

Pakistan can’t do such tricks with its foreign-currency denominated debt. And unfortunately, says Standard & Poors, about 40 per cent of its net government debt is foreign. So it is perpetually hunting for foreign exchange sources to cover these debts. Remittances is the most stable source of dollars and their ilk. US aid and the odd bit of money that can be squeezed from China and Saudi Arabia are another. Exports have done well, thanks to a genuinely competitive textile sector and a commodity boom that has held up grain and cotton prices. But export markets are saturated and so bringing India into that fold will help Pakistan squeeze another few years for its financial system.

One reason to give India most-favoured nation status after a 15 year wait.

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