A Fan Chart Approach to Debt Sustainability in Pakistan

Abstract

Pakistan’s economy has experienced relatively high growth of above 4.5 percent during FY2014-18. Meanwhile external liabilities and domestic debt have increased by almost 50 percent over the same period. This substantial increase in the external and domestic debt is a major issue for policymakers concerned about debt sustainability in Pakistan. With the objective of analyzing debt sustainability in Pakistan, this study applies a probabilistic approach to project the debt path from FY2019 to FY2025. In this approach, projections of the primary balance are derived from the estimated fiscal reaction function while the density forecast of external debt is derived from various statistical and structural models. The forecasts of the primary balance and the external debt along with the shocks of real GDP growth, real exchange rate and real interest are incorporated in the debt accumulation identity. This procedure provides a fan chart of the total debt-to-GDP ratio, which represents the appropriate uncertainty associated with the projections. The key finding of the paper is that external debt is reasonably sustained; however, the situation of the total debt is alarming. External debt may witness a declining trajectory in FY2019-20 and then remain stable within the range of 20-30 percent of GDP. However, the total debt-to-GDP ratio is rising throughout the projection period, which starts from around 100 to 175 percent of GDP in FY2020 and FY2025 and is higher than any sustainable threshold level. Therefore, policy makers need to contain fiscal deficits by domestic resource mobilization and the adoption of austerity in spending on a priority basis.