LocationsRedirecting Borrowing towards Productive Investment
By Tobias Akhtar Haque | Lead Economist & Program Leader, World Bank
Pakistan’s debt portfolio remains large and imposes significant liquidity risks; public borrowing continues to crowd out private sector credit; and much debt-financed expenditure is directed to purposes that will not generate long-term returns.
Debt can be a powerful tool for development. However, public borrowing in Pakistan is currently imposing substantial costs and risks. To maximize benefits and reduce risks, recent measures to constrain the fiscal deficit should be sustained. In the context of ongoing fiscal constraints, spending should be tightly prioritized, and all possible efforts should be taken to mobilize private investment.
Public Debt is an Important Tool for Development
Debt can be used to finance high-return investments in human capital and infrastructure, underpinning long-term economic growth. When countries face macroeconomic shocks, public borrowing can be used as a policy ‘buffer’, financing social protection spending, public services, or stimulus programs that help shield households and firms and avoid longer-term economic dislocation and scarring.
The Scale and Nature of Public Borrowing in Pakistan has Raised Costs and Risks
First, despite recent progress, Pakistan faces continued debt sustainability risks. Public debt has increased significantly over the past decade. Debt ratios remain well above limits established under the Fiscal Responsibility and Debt Limitations Act (which caps total public and publicly guaranteed debt at 60 percent of GDP). The composition of Pakistan’s debt portfolio is generally favorable, with a large share consisting of local currency debt from domestic sources and most external debt borrowed from official sources, often on concessional terms.
However, Pakistan needs to borrow a large amount every year to repay maturing debt due to reliance on short-term domestic debt and external deposits from ‘friendly’ countries. Financing needs amount to an average of 27.9 percent of GDP over FY 2025/2026. Importantly, gains are being made, with primary surpluses and lower interest rates driving debt down. Financing needs are expected to fall substantially over the coming years (the debt service-to-revenue ratio is expected to decline from 61.5 percent in FY 2024 to 43.8 percent by FY 2029).
Second, large domestic borrowing is absorbing private savings, leaving few resources available for private sector investment. Private savings are typically an important source of private investment, mediated by the banking sector. Savings rates in Pakistan remain low by international standards, limiting resources available for lending through the banking sector. Further, because government borrowing needs are high, more than 70 percent of bank lending is extended to the public sector. High levels of bank lending to the government directly crowds out resources available to the private sector and blunts incentives on banks to expand financial access.
Third, debt is mostly used to finance consumption rather than investment. The government contracts new debt equal to around 28 percent of GDP every year. However, total development spending currently equals around 2 percent of GDP. In contrast, recurrent spending equals around 18 percent of GDP every year, with interest payments constituting about 8 percent of the GDP and substantial allocations to salaries, pensions, and various subsidies and transfers. Pakistan spends little on health and education relative to other countries in the region at similar levels of development.
Overall, Pakistan’s debt portfolio remains large and imposes significant liquidity risks. Public borrowing continues to crowd out private sector credit, and much debt-financed expenditure is being directed to purposes that will not generate long-term returns.
Maximizing Benefits and Reducing Risks
First, the government should maintain recent progress with fiscal consolidation. With recent revenue and spending reforms, Pakistan is expected to achieve a primary surplus of 1.5 percent of GDP in FY 2025, an impressive turnaround. Efforts to raise revenues should continue, including through closing exemptions, increasing compliance, and mobilizing progressive new tax sources, including agricultural income and property taxes. The government should also continue to reduce spending on subsidies, rationalize public sector compensation, simplify the structure of government to address redundancies and overlaps, and reform pensions.
Strengthening the governance of State-Owned Enterprises (SOEs) and pursuing privatization where appropriate could reduce the current fiscal burden as federal SOEs cost taxpayers around 2.5 percent of GDP per year. Revenue reforms and targeted consolidation will protect fiscal space for critical investments in health, education, and social protection while allowing debt levels and financing needs to decrease over time.
Second, the government should strengthen debt-management institutions and practices. Addressing the current fragmentation of debt management institutions and ensuring all debt management decisions are made in alignment with a Medium-term Debt Management Strategy would ensure that borrowing choices are optimized to reduce costs and risks. Extending the average maturity of the debt portfolio is critical for addressing liquidity risks, with a smaller proportion of debt maturing (and requiring refinancing) each year.
Finally, and most importantly, reforms should be implemented to increase private investment. Currently, the levels are low at around 10 percent of the GDP compared to 20-30 percent of GDP for similar countries. In the current fiscal context, Pakistan will inevitably have limited space for public investment over the medium-term. The fiscal measures described above will have an important impact on increasing private investment, with reduced public borrowing leading banks to redirect lending towards the private sector. This is already happening with the share of bank lending to the private sector increasing from 24.3 percent in September 2023 to 28.4 percent in December 2024. In addition, Pakistan should:
Remove trade barriers to reduce the cost of imported inputs for exporters, facilitating Pakistan’s integration into global supply chains. International experience shows that such measures can bring new domestic and foreign investment while also increasing innovation, competition, and productivity.
Simplify the business environment and reduce red tape. Efforts should be made to remove redundant and outdated regulations and reduce the number of government agencies involved in overseeing private businesses - currently, the numbers stand at 40.
Provide reliable energy at lower costs. This must involve addressing the underlying drivers of high energy costs, including the weak performance of electricity distribution companies, inadequate transmission infrastructure, and an outdated and costly generation mix.