The federal budget 2025-26 allocated PKR 8.2 trillion for the payment of interest on debt, which is more than 74 percent of the net revenue receipt after divisible pool transfer to the provinces, 58 percent of the gross tax revenue, and 50 percent of the current expenditure. This huge spending restricts fiscal space for human welfare, subsidies, civil government operations, and development works.
Financing the fiscal deficit from domestic banking and non-banking sources is a current trend in Pakistan.
Now, the government avoids external borrowing because of its redemption and interest payments in a foreign currency. This year, PKR 7.3 trillion in borrowing is expected from banks and non-bank domestic sources.
Certainly, the cost of debt financing is much beyond the tolerable limit, while the macroeconomic conditions of Pakistan, particularly a stagnant, slow growth in GDP, dwindling trade-to-GDP ratio, and a shortfall in public revenue, do not allow the country to rely on further borrowing.
However, the present global scenario depicts a worse picture of the debt financing by the rest of the world, which should be reviewed before discussing Pakistan’s debt issues.
The aggregate global debt, including government, corporate, and household debts, is 235 percent of global GDP. It has crossed 264 percent in the USA and 294 percent in China. The high fiscal deficit is the main driver of rising global public debt.
However, corporate sectors in these countries are borrowing less due to subdued growth prospects, limiting private sector credit due to heavy public borrowing, increasing cost of debt, strong balance sheet positions, and cash holdings (in the USA).
At the end of 2025, the total global debt, including government, corporate, and household debts, was recorded at USD 324 trillion. Out of this, the government debt was USD 111 trillion, which shows a rise of USD 8.3 trillion from 2024.
The global government debt rose from 68 percent in 2005 to 95 percent of GDP in 2025, despite a decline in debt to GDP ratios in some countries, including Turkiye, Saudi Arabia, the Netherlands and Germany.
The debt level in advanced economies rose from 76 percent in 2005 to 110 percent of GDP in 2025.
Government gross debt to GDP ratio is 230 percent in Japan, 125 percent in the USA, 117 percent in France, 114 percent in Canada, 103 percent in the UK, 96 percent in China, 81 percent in India, and 74 percent in Pakistan.
Japan remains an outlier, with the highest debt among the major economies. Emerging markets and developing economies saw debt rise from 41 percent in 2005 to 73 percent of GDP in 2025.
China’s debt jumped sharply from 26 percent to 96 percent. These growing debts are likely to become more consequential due to the increasing cost of borrowing and declining GDP growth.
The United States and China hold 52 percent of global government debt, while their joint share in global GDP is 42 percent. The USA’s share in global GDP is 25.6 percent, China’s 16.5 percent, Germany’s 4.3 percent, Japan’s 3.5 percent, the UK’s 3.4 percent, India’s 3.3 percent, and France’s 2.8 percent.
Despite more than 100 percent debt-to-GDP ratios of advanced economies, 96 percent of China, and 81 percent of India, the 74 percent debt-to-GDP ratio of Pakistan is much debated and critical in different economic reports and media talks. Its only reason is the lack of financial liquidity in Pakistan. For several years (if not decades), Pakistan has been severely facing the insufficiency of foreign exchange reserves.
The repeated agreements with the IMF, taking hard decisions in compliance with international lending agencies and task forces, short-term borrowing from friends, and rising further debt in foreign currency to repay the existing debts, explore the liquidity issue.
The lack of foreign investment and stagnant exports are the root causes of this deficiency. The resolution of these two issues can resolve several issues: insufficiency of tax revenue, depreciation in Pakistani currency, unemployment, lower growth of GDP, and inflation. These problems are associated with these two issues.
The canon of economic policies in Pakistan has not been on resource mobilization, inducing investment, export enhancement, and efficient utilization of debt financing. The focus of policies is on reducing the debt burden.
The irrationally high tax-to-GDP ratio to pay the interest on debt is always a much-recommended policy measure in Pakistan.
The painful socioeconomic effects of this policy measure, including inflation, unemployment, and poverty, should not be avoided. Why should the policy measures not focus on accelerated GDP growth? The tax revenue targets can be achieved at a lower tax-to-GDP ratio with higher GDP growth.
To restrict public borrowing and deficit financing, the parliament had legislated the ‘Fiscal Responsibility and Debt Limitation (FRDL) Act’ in 2005, which is the fundamental legal framework to ensure fiscal discipline in the country.
The Act established specific statutory targets to enforce financial accountability. A reduction of total public debt to 60 percent of GDP, elimination of the revenue deficit (current expenditure exceeding revenue), a reduction in public debt by at least 2.5 percent of GDP annually until targets were met, restricting the issuance of new government guarantees to 2 percent of GDP in a fiscal year, were included in the legislative measures. Surprisingly, no government succeeded in executing this legislation.
Even the opposition parties have not firmly pointed out this violation.
The Act was amended in 2016 and 2022, and according to these amendments, a new target to reduce total public debt to 50 percent of GDP over 15 years starting from 2018-19 was set.
A centralized Debt Management Office within the Finance Division was established to consolidate debt functions and improve coordination. According to these amendments, the Ministry of Finance has to publish an annual Fiscal Policy Statement and Debt Policy Statement to allow Parliament to monitor compliance.
The act allows the government to depart from these targets only under exceptional circumstances, such as national security emergencies, natural calamities, or war. Despite these legal bindings, execution remains a challenge. Currently, Pakistan’s debt-to-GDP ratio stands at 74 percent, significantly above the 60 percent statutory limit.
How much debt is viable for a country? Academically, there is no defined level. The economists prefer to assess whether a debt-to-GDP ratio is stable or increasing. But this rule is not realistic in a real-world scenario.
A minor increase in interest rate or a minor decline in GDP growth can badly affect the debt-to-GDP ratio or the cost of debt to tax revenue ratio.
An interesting theory in political economy considers that public debt is a means by which governments can sabotage their opponents. There is a war of attrition in which each side would rather delay belt-tightening than accept austerity. An outgoing party cut taxes unreasonably just before it left the office.
The more disintegrated a political system, the more possibilities to raise debt financing. Proportional voting systems and coalition governments are compelled to keep everyone happy.
Inflexible constitutional limits provide a shield against the irresponsible attitude of outgoing ruling parties, but such limits also reduce flexibility. This can hamper the ability to invest in much-needed infrastructure projects and required spending on defence.
The debt will remain a viable option if its cost (interest on debt and dividends on foreign or participating domestic investment) is less than the incremental GDP growth.
Another view in economic literature is that income inequality increases when the rate of return on capital exceeds the rate of GDP growth. It is a misleading approach that external liabilities should tend to be zero. If debt (external or domestic) financing improves the earning power of domestic assets, it will always be a good option. Otherwise, it will shift the burden of repayment to the taxpayers.
Debt sustainability is eventually related to the cost of debt and the benefits from its utilization. The debt will become a problem only if its cost cannot be recovered through incremental growth, and the government has to generate funds from the public to pay the cost of debt.
The types and sources of debt are also important in making the decision for public borrowing.
The overall debt of a country is divided into public and private sector debts. These are further classified into external debt and domestic debt (or credit in broader terms).
In this way, Pakistan’s public debt (including publicly guaranteed corporations) is 74 percent of GDP; 33 percent of this 74 percent is external public debt, and the remaining is domestic debt to the public sector.
Pakistan’s private sector external debt is around 5 percent of GDP, and domestic credit to the private sector is 11 percent of GDP. So, the total debt (public, private, external, and domestic) to GDP ratio is 90 percent.
Empirical evidence indicates that external debts are commonly used for politically motivated popular projects that are not feasible for long-term and perpetual economic growth. The development work through external debt under ‘populism’ does not improve productivity and economic growth. It creates an unreasonable debt burden.
The term “Populism” is widely used in the contemporary literature of economics and political science. It explains the phenomenon when political parties support those public demands that may be harmful in the long term. Populism is most common in dem ocratic nations.
However, popular public views or political statements may not necessarily be trustworthy for sustainable economic policies for the nations. The provision of subsidies, support pricing, nationalization, and over-employment in the public sector are examples of populism.
It is also a global phenomenon that, in the presence of external borrowing, governments avoid higher tax collection.
In the presence of external debt, governments can get political benefits from lower taxes and higher subsidies. These debts are also used to subsidize the growth in private business activities and provide a substitute for taxes. It was noted that the direct, immediate effect of external long-term debt on GDP growth is significantly negative.
Long-term debt is commonly utilized for long-term projects, which provide benefits in the future. Such long-term debts can engage the national resources for future development and growth.
Copyright Business Recorder, 2026
The author is a professor at Iqra University Karachi.