Islamabad, 10 August 2024 (TDI): A recent assessment from the Finance Ministry estimates that in case of a new macroeconomic or fiscal shock, Pakistan’s debt will rise to unsustainable levels, reaching a record Rs74.6 trillion.
According to the Ministry of Finance’s Debt Sustainability Analysis Study for 2025–2027, Pakistan is still vulnerable to a number of issues associated with debt sustainability because of its high debt load and the ensuing need for gross financing.
The analysis indicates that although the debt profile is manageable in the long run. But it is very susceptible to external shocks and structural weaknesses, especially because of the substantial amount of foreign and floating-rate domestic debt.
Pakistan’s overall public and publicly guaranteed debt has increased significantly, with the finance ministry stating that it stood Rs74.6 trillion by the end of June 2024. The national debt load rose by Rs8.2 trillion, or 12.3%, in the last fiscal year, accounting for 70.5% of GDP. Debt-to-GDP ratio should have been less than 57.5%, per the Debt Limitation Act.
The fact that Pakistan’s debt load is greater than the legal limit maximum suggests that it cannot continue. Nonetheless, in order to prevent the need for an urgent restructuring of both domestic and foreign debt, the International Monetary Fund (IMF) continues to deem it sustainable.
According to the data from the finance ministry, financing the federal fiscal deficit was the primary cause of the notable growth in the public debt, with interest costs playing a substantial role.
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According to the finance ministry’s baseline scenario, the debt-to-GDP ratio will fall between FY2025 and FY2027, from 68.5% to 66.4%. Nevertheless, the likelihood of a mix of macroeconomic and fiscal shocks could put the ratio beyond 70% and jeopardize the sustainability of the debt, endangering this optimistic scenario.
The Finance Ministry states that in a combined macro-fiscal shock scenario, the debt-to-GDP ratio would rise above the 70% mark, endangering the sustainability of the debt. The debt-to-GDP ratio might also rise to 75% in a macro-fiscal shock, 8.6% higher than in the base case.
The Pakistani government’s overall finance needs would be around 22.6% of GDP, or 3.2% more than predicted by the baseline. Financing needs of 15% of GDP are deemed reasonable for a growing nation such as Pakistan.
In the medium term, public debt and gross financing needs as a ratio of GDP could rise dramatically, the finance ministry warns, due to factors including lower-than-expected economic growth, an increase in the primary deficit, a rise in real interest rates, a spike in contingent liabilities, and exchange rate depreciation.
It is also noted in the report that concessional bilateral and multilateral sources account for the majority of Pakistan’s foreign debt. Despite the expectation that the maturity structure will span a three-year period, the increasing proportion of short-term debt in recent times raises concerns about the sustainability of debt because of the high risk associated with refinancing, which raises gross financing needs overall.
Of the entire amount of external Pakistan’s debt in the portfolio, 63% is made up of fixed-rate debt and 37% is made up of floating-rate debt. At the end of June, domestic debt made up 66.2% of all governmental debt, most of which has a long maturities.
The finance ministry claims that there is a substantial interest rate risk due to the sizeable portion of domestic debt that is floating-rate debt. Of all domestic debt, 26% is made up of fixed-rate debt and 74% is made up of floating-rate debt.
Baseline Situation
For FY2025, the finance ministry’s baseline scenario projects 3.6% economic growth. The average rate of inflation may be 12% in FY2025 and only 1% in FY2026.
Due to a positive current account balance, the currency rate stabilized in FY2024 and is expected to stay steady going forward. The federal primary balance is expected to dramatically improve during FY2025-27, in line with the government’s attempts to achieve fiscal consolidation.
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Shock Situation
A quick change in the main balance is not out of the question because of the fiscal space constraints, according to the finance ministry. The debt-to-GDP ratio will surpass the 70% benchmark and endanger the sustainability of debt if a shock hits the primary balance, raising the primary deficit near historical levels.
According to the ministry of finance, in the event that economic growth stays at 2.6% throughout this fiscal year, the debt-to-GDP ratio will rise above the 70% threshold and might potentially reach 70.6% in calendar year 2027. Throughout the medium run, the negative GDP growth shock will consistently maintain the debt-to-GDP ratio at 70% or above.
Domestic debt is sensitive to shocks in nominal interest rates due to the significant proportion of floating-rate debt in it. Nominal interest rates may have a negative effect on debt-to-GDP ratios given the low foreign exchange reserves and limited availability of market financing.
Exchange rate depreciation resulting from a high proportion of external Pakistan’s debt adds to the dangers associated with it. As per the finance ministry, Pakistan is vulnerable to concerns such as insufficient export receipts, increasing imports, and a declining current account deficit, which could put pressure on the currency rate, even as its ability to fulfill its external debt commitments keeps up.
