Zafar Iqbal

The national government’s debt rose to Rs48.4 trillion in August 2024, marking a 21 percent increase from the previous year. Despite this, the debt-to-GDP ratio decreased from 74 percent to 66 percent. This seemingly contradictory situation can be explained by the fact that inflation has outpaced debt growth, resulting in improved debt figures at the expense of reduced purchasing power.

Over the past two years (July 22- Jun 24), public debt (both domestic and external) has increased by 45 percent, while headline inflation has risen by 49 percent, and GDP (at market prices) has grown by 58 percent. This indicates that inflation has outpaced debt growth during this period.

It’s worth noting that the central public debt figures do not encompass significant government unfunded pension liabilities, amounting to Rs11 trillion in Punjab alone. When factoring in federal (including military) and provincial pension liabilities, the total is estimated to be around Rs30–35 trillion, surpassing the country’s total external debt.

Therefore, the apparent improvement in the debt-to-GDP ratio should be viewed with caution. While it may seem positive, it’s important to note that this reduction is primarily due to high inflation. If inflation subsides, the debt-to-GDP ratio may not continue to decline at the same rate. This has implications for the country’s economic stability and the government’s ability to manage its debt effectively.

It’s imperative that we shift our immediate focus to reducing the government’s fiscal deficit in the short term and the primary fiscal deficit in the medium term. However, it’s important to note that domestic debt servicing may not decrease as rapidly as inflation, as debt repricing takes time and the State Bank of Pakistan (SBP) is expected to maintain high real positive interest rates.

One of the government’s main priorities should be to reprofile domestic debt. This involves restructuring the debt portfolio to reduce the risks associated with rolling over and repricing. Currently, the majority of market debt is concentrated in T-Bills and floating-rate Pakistan Investment Bonds (PIBs), including their Islamic counterparts. By reprofiling the debt, the government can mitigate these risks and improve its debt management strategy.

Out of the Rs37.8 trillion domestic public debt (excluding SBP debt and unfunded debt such as National Savings Schemes), only 19 percent is in fixed-rate instruments. The cost of floating-rate debt is considerably higher, with average yields on fixed PIBs at 13.7 percent (10-year PIBs at 11.7% versus 3-year PIBs at 17.1%). This contrasts sharply with the average yields on PIB floaters and T-Bills, which are hovering around 20–21 percent.

Had the government accumulated more fixed-rate PIBs, especially with longer maturities, the burden of debt servicing in the last two years could have been lower. For instance, fixed PIB yields increased from 11.0 percent in June 2022 to 13.7 percent in September 2024, while T-Bill yields surged from 8.6 percent to 20.7 percent over the same period.

In an economy where interest rates have been highly volatile, fluctuating between 6 and 22 percent from 2014 to 2024, the significance of increasing fixed-rate bonds cannot be overstated.

With interest rates currently trending downward, this presents an opportune moment for the government to shift its debt profile towards long-term fixed-rate instruments. This strategic move will enhance resilience against potential future crises, where inflation and interest rates may rise again, and pave the way for a more stable financial future.

At present, 10-year PIB secondary market yields are approximately 12 percent, close to the yield on similar tenure papers the government already holds. It is advisable for the government to continue issuing more long-term fixed-rate bonds until interest rates reach their lowest point.

By augmenting the share of long-term fixed bonds, the government can play a pivotal role in enhancing the yield curve. This will not only encourage a market for pension funds but also support long-term financing for private sector projects and much-needed housing mortgages, demonstrating the government’s proactive stance in shaping the financial landscape.