Redirecting borrowing toward productive investment, private sector credit continues to be displaced by public borrowing. Pakistan's debt portfolio remains sizable and poses significant liquidity risks, with a substantial portion of debt-financed spending allocated to non-long-term objectives.
Public debt has the potential to serve as a powerful tool for development. However, it is currently imposing significant costs and risks, particularly in the context of public spending. Current fiscal deficit restraint measures should be maintained to optimise benefits and minimise risks.
Given persistent financial constraints, expenditures should be carefully prioritised and every effort should be made to encourage private investment. Long-term economic growth can be supported by debt financing for high-return investments in infrastructure and human capital. Public borrowing can also serve as a policy buffer to finance public spending, social protections and essential services when nations are unable to meet their obligations. In Pakistan, however, the scope and character of public borrowing have increased both expenses and risks.
First, Pakistan still faces significant debt sustainability risks, despite recent improvements. Over the past decade, public debt has increased notably. The Financial Responsibility and Debt Limitation Act, which sets a ceiling of 60 per cent of GDP on total public and publicly guaranteed debt, seeks to curb this growth. While Pakistan's debt portfolio is broadly favourable, with most external debt coming from official sources, often on concessional terms and a sizable portion comprising domestic, local currency debt, the country remains reliant on short-term domestic borrowing and external deposits from ‘friendly nations’.
As a result, Pakistan must borrow a substantial amount each year to roll over its maturing debt. Over FY2025–2026, financing needs are expected to average 27.3 per cent of GDP. Encouragingly, gains are materialising, primarily due to lower interest rates and primary surpluses.
The government must stay aligned with recent progress in fiscal consolidation. Pakistan is projected to achieve a primary surplus of 1.5 per cent of GDP, based on current revenue and expenditure trends. FY2025 witnessed a remarkable 11.2 per cent of GDP turnaround. Efforts to enhance revenue collection must continue – by tightening exemptions, improving compliance and mobilising progressive new tax sources, including agricultural income and property taxes.
Other key measures include simplifying the government’s administrative structure to eliminate overlap and redundancy, adjusting public sector compensation to reduce subsidy costs, reforming retirement plans and improving the governance of state-owned enterprises (SOEs). Where feasible, SOEs should be privatised to reduce the fiscal burden, currently around 1.5 per cent of GDP annually, on taxpayers. These targeted actions and income reforms will be vital.
Consolidation will help safeguard fiscal space for essential investments in health, education, climate resilience and social protection, while also enabling a gradual reduction in financing needs and debt levels.
Second, the government needs to strengthen debt management systems and institutions. It is crucial to address the fragmentation across debt management agencies and ensure that all decisions are informed by a medium-term debt strategy designed to mitigate risks. A comprehensive debt management plan will ensure borrowing decisions are focused on minimising costs and risks. Managing liquidity risks depends on increasing the average maturity of the debt portfolio, thereby reducing the proportion of debt coming due annually and the need for frequent refinancing.
Strengthening the development of the debt portfolio is essential to reducing liquidity risks by ensuring a smaller share of debt matures (and requires refinancing) each year. This trend is already underway, with the share of bank lending to the private sector increasing from 24.3 per cent in September 2023 to 28.4 per cent in December 2024.
Pakistan should also remove trade barriers to reduce the cost of imported inputs for exporters, thereby supporting the country’s integration into global supply chains. Global experience shows that such measures can attract new domestic and foreign investment while boosting growth, competition, and productivity. Simplifying the business environment and reducing red tape are equally important steps in this process.
The writer works on climate finance, carbon markets and sustainable development across disaster risk reduction and climate change.
