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Pakistan's Debt Dilemma

Pakistan is facing serious debt challenges. What are these challenges and how can they be overcome? What is the outlook for Pakistan’s economy if the current situation persists in the coming years? How can politicians and officials face up to the challenges ahead?

The overlapping generations model[1] provides a comprehensive analysis of the negative consequences associated with high levels of debt. These repercussions include adverse effects on economic growth, altered expectations, increased uncertainty, changes in sovereign yield spreads, and real interest rates. Ultimately, these factors can lead to reduced levels of private investment when a country's revenue growth is unsustainable.

Regardless of whether a country is developed or developing, a high debt-to-GDP ratio increases the likelihood of default. The level of debt relative to the size of the economy becomes a crucial factor in assessing the country's ability to meet its debt obligations. In December 2022, for example, the United States had a debt-to-GDP ratio of 123.4%, and warnings were issued by the Congressional Budget Office and the U.S. Department of the Treasury about reaching a critical threshold known as the "X-date." This refers to a point where the government may struggle to meet its financial obligations.

Extensive research covering forty-four countries[2] over five decades reveals a significant association between a debt-to-GDP ratio exceeding 60% and default risk. It also highlights the considerable risk to sustained economic growth when the debt burden surpasses this threshold. In Pakistan, the debt-to-GDP ratio stood at approximately 75% in 2022, with external debt reaching $125.7 billion in March 2023. However, this figure exceeded the threshold of 58% mandated by the Fiscal Responsibility and Debt Limitation Act, which the government has failed to achieve in the last two years. The debt level is expected to rise further if the government does not take appropriate action.

Regarding the current budget, the estimated target revenue collection in Pakistan is projected to be around Rs8.6 trillion to Rs9.2 trillion in 2023-24. However, debt servicing costs exceeding Rs7.3 trillion, are expected to absorb most of this revenue. Other significant budget allocations that need to be financed include defense spending, government pensions, salaries, the development budget, and subsidies.

A week before the budget speech in June 2023, the government decided to enact a supplementary budget of over Rs402 billion specifically allocated for debt servicing purposes. Over the past year, the government has maintained an average daily borrowing of Rs41 billion to fund its operations. The total government debt increased by Rs58.599 trillion from Rs14.89 trillion, with Rs36.55 trillion from domestic sources and Rs22.050 trillion from foreign sources.

The budget deficit is also rising. If revenue remains at Rs9.2 trillion in fiscal year 2023-24, the deficit could reach 6.4% of GDP. The government plans to acquire Rs3.1 trillion from banks and Rs1.9 trillion from non-banks to repay existing debt, reducing its liabilities but increasing overall debt. Additionally, Rs1.1 trillion in subsidies will be financed through debt and recovered through increased taxation, placing a burden on the public through higher taxes.

However, the government's approach of rescheduling debts and taking on more debt from the market raises concerns about the high-risk exposure of the banking sector to the state. Over 80% of bank lending is directed towards the government. Incurring additional debt in this manner creates a debt trap that negatively impacts public welfare and will increase tax burdens in subsequent years.

Pakistan's tax structure tends to favor regressive indirect taxes, which make up around 60% of total taxes. Around 70% of direct taxes are derived from withholding taxes. Excluding withholding taxes, the share of direct taxes in total tax collection decreases significantly. Governments around the world often impose new taxes or raise the rates of indirect taxes to generate revenue and meet deficits.

Yet such policies can lead to cost-push inflation, increased business costs, reduced purchasing power, and may contribute to economic and social inequalities. If this situation persists, Pakistan's inflation rate could exceed 30% per year, impacting on local production and increasing the demand for foreign exchange, potentially causing the national currency to depreciate.

Poverty rates in Pakistan have risen, and the middle-class population has shrunk over the past decade. These circumstances pose a significant threat to the stability of the state-citizen social contract and undermine the shared understanding between them.

Mainstream political parties should prioritize the development of an economic charter that focuses on sustainable economic systems to alleviate fiscal deficits, empower the local business ecosystem, and break the cycle of the debt trap. This requires implementing tax reforms to broaden the tax base instead of burdening existing taxpayers. It is also crucial to reduce unproductive expenses, irrational subsidies, and tax rebates while empowering local businesses by lowering business costs.

Enacting proactive policies such as these would contribute significantly to establishing a sustainable and fair economic framework. Failing to address the current debt trap could result in public discontent, leading to support for populist or extremist political parties. Such circumstances could also lead to heightened polarization, division, and frustration among the citizens and especially the youth of Pakistan.

Relying exclusively on external debts, whether from the West or the East, will prove insufficient to rescue Pakistan from its economic and financial challenges. The nation must strive to establish a robust and sustainable economic governance ecosystem.


[1] The OLG model serves as the foundational framework for analyzing: (a) life-cycle behavior encompassing human capital investment, labor participation, and retirement savings. (b) The long-term impact of resource allocation across generations, including social security, on per capita income. (c) historical determinants of economic growth.

(d) Factors responsible for initiating the fertility transition. (


[2] Matsuoka, H. (2015). Fiscal limits and sovereign default risk in Japan. Journal of the Japanese and International Economies38, 13-30.(