Fiscal reforms are key to Pakistan’s debt sustainability

• The debt-to-GDP ratio is projected to decrease gradually.
• External factors such as the exchange rate affect debt sustainability.
• Contingent liabilities remain a significant risk to debt dynamics.

Islamabad: The Ministry of Finance has conducted a Debt Sustainability Analysis (DSA) for the period 2025-2027, looking at six scenarios, The News reported, with the analysis recognizing persistent uncertainties stemming from high gross financing needs.

According to the DSA Report 2025-2027, the ratio of public and publicly guaranteed debt (PPG) to GDP is projected to decrease from 68.6% in 2025 to 66.6% in 2027.

This reduction is attributed to fiscal consolidation and the favorable growth rate differential, which contribute to a downward trajectory for the public debt to GDP ratio.

In the baseline scenario, the government debt-to-GDP ratio remains below the prudent benchmark, while the GDP-to-GDP ratio is expected to decline steadily from 25.4% in 2025 to 19.5% in 2027.

This suggests moderate risk to debt dynamics over the medium term.

The analysis notes that debt dynamics are influenced by both external and internal factors. “Despite improvements in debt dynamics over the medium term, risks to public debt remain high,” the report said.

A heat map highlights the risks, showing that the debt-to-GDP ratio is slightly above the limits in the baseline scenario (70.4% in FY2024). The DSA sets benchmarks for emerging markets at 70% for the public debt-to-GDP ratio and 15% for the GDP-to-GDP ratio.

“However, the GFN-to-GDP ratio remains high at baseline, indicating a risk to debt sustainability. Pakistan’s debt dynamics are further complicated by potential deviations in the federal primary balance, exchange rate depreciation, slowing economic growth and the emergence of contingent liabilities,” the report warns.

Key drivers of debt ratio and GFN growth include these risks, although improvements in quasi-fiscal transactions, external financing requirements and market access during the review period provide some relief.

The analysis highlights the limited shock-absorbing capacity of the primary balance. While the main fiscal projections show a steadily improving primary balance due to fiscal consolidation and solid economic growth, the tight fiscal space leaves room for unexpected changes.

For example, a 50% reduction in the planned primary balance would raise the debt-to-GDP ratio to 69.4% in 2027, but keep it sustainable in the medium term.

Conversely, if the primary deficit returns to its historical average (-1.6% of GDP), the debt-to-GDP ratio will rise to 73.1%, putting sustainability at risk.

Undesirable events, such as significantly slower economic growth, could also exacerbate debt dynamics. A stress test shows that a 1% standard deviation shock to economic growth in 2025 would push the debt-to-GDP ratio to 70.7% by 2027, undermining debt sustainability.

Real interest rate risks remain moderate. The high share of floating-rate domestic debt (74% in December 2023) makes domestic debt vulnerable to shocks in nominal interest rates.

These shocks could increase interest payments in the short term. However, the negative spread between real interest rates and growth helps limit the impact of nominal interest rates on the debt-to-GDP ratio and GDP. In this scenario, the debt-to-GDP ratio would reach 68.1% in 2027, compared to 66.6% under the baseline.

The high rate of external debt poses additional risks through exchange rate depreciation. While Pakistan’s ability to repay its external debt obligations is considered adequate, risks arise from insufficient export receipts, rising imports and a worsening current account balance.

The stress analysis suggests that exchange rate depreciation could increase the debt-to-GDP ratio to 68.2% by 2027, compared to 66.6% in the baseline.

In a combined macroeconomic shock scenario, the PPG debt-to-GDP ratio would exceed the 70% threshold, reaching 75.2% in 2027. Lower-than-expected economic growth, an increase in the federal primary deficit, higher interest rates and exchange rate depreciation could significantly increase public debt and GDP as a percentage of GDP.

These simultaneous crises highlight the interplay between macroeconomic and fiscal factors, posing significant risks to debt sustainability.

The analysis also highlights the vulnerability of public debt to rising contingent liabilities. In this scenario, the debt-to-GDP ratio would rise from 68.6% in 2025 to 72.8% in 2027.

A narrowing of the primary balance due to higher non-interest spending will further worsen public debt, with the GFN rising by 2.1 percentage points of GDP over the medium term, the report concludes.