Pakistan’s financial situation is currently overshadowed by mounting concerns over its burgeoning debt. With both external and domestic debts escalating to unprecedented levels, the nation finds itself in a precarious situation.

The composition of this debt, particularly the significant portion tied to floating interest rates, poses substantial risks, especially in the face of potential economic and fiscal shocks. As Pakistan’s public and guaranteed debt catapulted to an unprecedented Rs74.6 trillion by June’s conclusion, a fresh evaluation from the Finance Ministry cautions that any emergent macroeconomic or fiscal perturbation could propel the debt and financing requisites into untenable terrains.

The Ministry of Finance’s Debt Sustainability Analysis, covering 2025-2027, divulges that the towering debt encumbrance and its accompanying extensive financing needs leave Pakistan perilously susceptible to debt sustainability quandaries. “The debt contour remains tenable over the intermediate horizon but is beleaguered by substantial perils from external tremors and inherent structural frailties, notably due to the considerable share of external and variable-rate domestic debt,” the report elucidates.

Delving into specifics, the report expounds that Pakistan’s aggregate public and publicly guaranteed debt has ascended significantly, now perched at Rs74.6 trillion as of June 2024, as per the finance ministry’s records. Throughout the preceding fiscal cycle, the public debt load swelled by Rs8.2 trillion, reflecting a 12.3% uptick, encapsulating 70.5% of the GDP. The Debt Limitation Act stipulates that the debt-to-GDP ratio ought to remain beneath 57.5%.

This surpassing of the statutory debt boundary underscores the unsustainable nature of Pakistan’s debt burden. Nonetheless, the International Monetary Fund (IMF) persists in classifying it as sustainable, likely to forestall an exigent restructuring of domestic and foreign obligations. The finance ministry’s exposition further attributes the pronounced escalation in public debt chiefly to the financing of the federal fiscal shortfall, with interest disbursements being a predominant element. Under the baseline projection, the ministry forecasts a descending trend in the debt-to-GDP ratio from FY2025 to FY2027, fluctuating between 68.5% and 66.4%. However, this sanguine prognosis is jeopardized by the potentiality of compounded fiscal and macroeconomic perturbations, which could propel the ratio beyond 70%, imperiling debt sustainability.

In a scenario of combined macro-fiscal disturbances, the debt-to-GDP ratio might transcend the 70% threshold, imperiling debt sustainability, as per the finance ministry’s projections. Furthermore, such a macro-fiscal upheaval could elevate the debt-to-GDP ratio to 75%, which is 8.6% above the baseline estimation.

Consequently, the aggregate financing requisites of the Pakistani government would hover around 22.6% of GDP—3.2% higher than the baseline conjecture. For an emerging nation like Pakistan, financing demands of 15% of GDP are deemed manageable.

The finance ministry forewarns that factors such as underperforming economic growth, a surge in the primary deficit, elevated real interest rates, an upsurge in contingent liabilities, and currency depreciation could markedly inflate public debt and gross financing necessities, relative to GDP, over the medium term.

The report also underscores that Pakistan’s external debt is predominantly sourced from concessional bilateral and multilateral avenues. While the maturity framework is anticipated to elongate across the three-year span, the burgeoning share of short-term debt in recent years amplifies risks to debt sustainability due to heightened refinancing peril, further exacerbating gross financing demands.

Within Pakistan’s external debt portfolio, fixed-rate debt comprises 63% of the total, while floating-rate debt accounts for the remaining 37%. On the domestic front, which made up 66.2% of the overall public debt by June’s end, the debt predominantly carries long-term maturities. However, the significant proportion of floating-rate debt within the domestic segment introduces a considerable interest rate risk, as highlighted by the finance ministry. Fixed-rate debt constitutes merely 26% of the total domestic debt, leaving a substantial 74% exposed to fluctuating interest rates.

In the baseline scenario, the finance ministry anticipates that the economy will expand by 3.6% in FY2025. Inflation is projected to average 12% for the same fiscal year before descending into single digits by FY2026. The exchange rate, having stabilized in FY2024 amidst a favorable current account balance, is expected to maintain its stability in the medium term. In line with the government’s fiscal consolidation strategies, the federal primary balance is forecasted to improve significantly throughout FY2025-27.

However, the finance ministry warns that given the constrained fiscal space, an abrupt shift in the primary balance is not out of the question. Should a shock cause the primary deficit to swell to historical levels, the debt-to-GDP ratio could breach the 70% mark, jeopardizing debt sustainability.

Moreover, the ministry notes that if economic growth remains sluggish at 2.6% this fiscal year, the debt-to-GDP ratio will not only exceed the 70% threshold but could also climb to 70.6% by FY2027. Such a persistent GDP growth shock would likely keep the debt-to-GDP ratio at or above 70% over the medium term.

The large proportion of floating-rate debt within the domestic debt structure also renders it vulnerable to shocks in nominal interest rates. With dwindling foreign exchange reserves and limited market financing options, fluctuations in nominal interest rates could adversely affect the debt-to-GDP ratios.

Additionally, the high share of external debt presents further challenges to debt sustainability, particularly through potential exchange rate depreciation. While Pakistan’s ability to meet its external debt obligations remains sufficient for now, it is susceptible to risks stemming from inadequate export revenues, rising import costs, and a worsening current account balance, all of which could place additional pressure on the exchange rate, according to the finance ministry.

As Pakistan grapples with the complexities of its debt portfolio, the path to sustainability remains fraught with challenges. The high proportion of floating-rate debt, both domestically and externally, makes the country vulnerable to interest rate shocks and exchange rate fluctuations. While the government’s fiscal consolidation efforts offer a glimmer of hope, the looming risks cannot be ignored. Sustained economic growth, prudent fiscal management, and strategic debt restructuring will be crucial in steering Pakistan towards a more stable financial future. Without these measures, the nation’s debt burden could reach unsustainable levels, threatening long-term economic stability.