AN INVESTIGATION OF DEBT DYNAMICS IN CASE OF PAKISTAN: EXPLORING THE DETERMINANTS OF ESCALATING DEBT AND ASSESSMENT OF DEBT SUSTAINABILITY

Abstract

The purpose of this study is to examine that are responsible for the escalating public debt burden in case of Pakistan. The public debt dynamic model for the period of 1975-2019 is used for this purpose. The changes in the public debt as percent of GDP which is dependent variable and explanatory variables of the models are primary balance, real GDP growth rate, exchange rate depreciation, real interest rates and seigniorage. ARDL cointegration model was applied to investigate the long term and short-term relationship between public debt to GDP ratio and its important determinants. The primary balance has significant and negative relationship with the public debt to GDP in the long term as well as in the short term. The real interest rate, exchange rate, seigniorage, output gap and non-current account balance have significant and negative association with public debt to GDP. High current account and fiscal deficits, a shortfall in foreign exchange reserves that contributed to a sharp depreciation of the Pakistani rupee and rising inflationary pressures that resulted in a tight monetary policy stance and a significant increase in debt servicing costs are some of the factors that have contributed to the alarming growth in debt. This study also examined sustainability of public debt, by using two approaches of standard IMF debt sustainability analysis. First is checking the nature of public debt to GDP whether it is stable or not and the second is analysing debt stabilizing primary balance by comparing the Pakistan’s historical and expected primary balances to the debt stabilising primary balance for each year. The results of first approach shows that public debt to GDP is found to be explosive for majority of time period with only exception of few years. In the second debt sustainability analysis approach, IMF introduces combined shocks to real interest rate, primary balance, real GDP growth and 30% of exchange rate depreciation has the potential to increase the public debt to GDP ratio in medium term (2020-25). For which sufficient amount of primary surplus is needed to stable the public debt as percent of GDP.