With the boom and bust cycles in economies’ growth patterns and fiscal uncertainties, the sustainability of public debt assumes immense importance. In Pakistan’s case, macroeconomic vulnerabilities and fiscal policies weave an intricate web around the country’s debt trajectory and thus raise questions of ultimate importance to long-term stability.

The recent Debt Sustainability Analysis (DSA) from the Ministry of Finance for 2025-2027 outlines the risks and resilience built into the fiscal framework of the nation. It presents how adverse economic scenarios and macro-fiscal shocks might influence debt metrics and stresses the need for strategic policy interventions to counter such risks. The Ministry of Finance has conducted an elaborate Debt Sustainability Analysis for the fiscal years 2025 to 2027, accepting that there are still several ambiguities arising from huge gross financing needs.

The DSA report states that the PPG debt-to-GDP ratio is expected to decline from 68.6 percent in FY2025 to 66.6 percent in FY2027. This improvement is credited to tight fiscal discipline and favorable interplay between the expansion in the economy and interest rate dynamics, which together support the declining trajectory of the debt-to-GDP ratio.

Under the baseline scenario, the debt-to-GDP ratio remains persistently below the threshold set for prudence, while the GFN-to-GDP ratio is expected to decline from 25.4% in FY2025 to 19.5% in FY2027. This would imply a softened risk to fiscal stability in the medium term. The analysis further highlights that the debt trajectory remains sensitive to the interplay of external and domestic factors. Despite observable progress, the report asserts that “public debt risks endure at elevated levels.”

A diagnostic heat map highlights areas of vulnerability, where the debt-to-GDP ratio is slightly over threshold levels in the baseline projection—at 70.4% in FY2024. The DSA limits for emerging markets place the cap at 70% for the debt-to-GDP ratio and 15% for the GFN-to-GDP ratio. “However, the GFN-to-GDP ratio is still surprisingly high in the baseline forecast, and pressures on debt sustainability continue unabated.”. Pakistan’s fiscal environment is further complicated by the possibility of disturbances in the federal primary balance, the weakening of the exchange rate, slow economic growth, and the emergence of contingent liabilities,” the report warns. Chief factors driving debt and GFN ratios to deteriorate are these risks, though progress in quasi-fiscal mechanisms, imperatives of external borrowing, and access to broader markets during the review period offer tempered comfort. The analysis highlights limited resilience to primary balance shocks.

Baseline fiscal paths assume a continually improving primary balance, as constrained by fiscal consolidation and continued economic growth. In turn, the tight fiscal space provides little room for unanticipated shocks. For example, reducing the assumed improvements in the primary balance by half would increase the debt-to-GDP ratio to 69.4 percent by FY2027, yet maintain medium-term tractability. Conversely, a return to the historical average primary deficit (-1.6% of GDP) could push the debt-to-GDP ratio to 73.1%, threatening fiscal sustainability.

Adverse developments, including a marked slowdown in economic growth, would significantly worsen debt dynamics. Stress-testing shows that a 1 percentage point deviation in economic growth for FY2025 would push the debt-to-GDP ratio to 70.7 percent by FY2027, thus putting fiscal sustainability at risk.

Risks related to real interest rates are moderate but still significant. As a result, the large portion of floating-rate domestic debt at 74% as of December 2023 leaves domestic liabilities particularly vulnerable to shocks in nominal interest rates, which may drive up short-term interest expenses. Still, this impact is mitigated by a negative gap between real interest rates and economic growth, which has the effect of reducing the debt-to-GDP ratio and gross financing needs (GFN) that are influenced by the nominal interest rate. Under such conditions, the debt-to-GDP ratio can reach 68.1% in FY2027 against the baseline projection at 66.6%. External debt risks are exacerbated by vulnerabilities to exchange rate depreciation. Even though Pakistan’s current capacity to meet external debt obligations is sufficient, the challenges could emerge in the future. The challenges may include a lack of export earnings, an increase in imports, and a growing current account deficit. Stress assessments suggest that the debt-to-GDP ratio could be pushed up to 68.2% by FY2027 compared to the baseline figure of 66.6%.

As with the compounded macro-fiscal shock scenario, the debt-to-GDP ratio on PPG could exceed this critical 70% mark, reaching an alarming high of 75.2% by FY2027. This scenario highlights not only the impact of very weak economic growth but also expanded federal primary deficits coupled with rising interest rates, which together increase the weight of public debt and the GFN. These interacting shocks illuminate the fragile interplay between macroeconomic and fiscal stressors, rendering it a tough challenge in maintaining debt sustainability. The analysis also draws attention to the growing risk emanating from burgeoning contingent liabilities. In such a scenario, the debt-to-GDP ratio could rise from 68.6% in FY2025 to 72.8% by FY2027. In addition, a reduced primary balance-resultant from increased non-interest expenditures-would aggravate public debt concerns, lifting the GFN by yet another 2.1 percentage points of GDP during the medium term.

The DSA findings are quite telling in the sense that fiscal sustainability is achieved by walking on a tightrope balancing complex economic dynamics. Even though Pakistan has shown resilience in the management of its debt obligations, risks such as slow growth in the economy, volatile interest rates, and currency depreciation require robust fiscal adaptation strategies. Contingent liabilities will be one area requiring immediate attention, coupled with an enhanced fiscal discipline mechanism. In a context fraught with uncertainty, proactive governance, combined with comprehensive reforms, will be indispensable to sustaining debt and achieving economic stability.