Debt sans reform traps growth

ISLAMABAD:

Debt is not inherently harmful if it is used productively – borrowed to invest in future yield-generating projects such as infrastructure and high-tech education. Nations like Japan, the US, China, Singapore and India have used debt efficiently to strengthen their economies and boost future income. However, debt borrowed for deficit financing or consumption becomes a burden.

Sri Lanka, Argentina and Pakistan are struggling with debt accumulated due to persistent deficits and non-development spending. Excessive non-productive borrowing crowds out investment, raises interest costs and increases default risks, ultimately harming long-term growth, as seen in recent crises in Sri Lanka and Pakistan.

Pakistan’s external debt and liabilities have reached $138.01 billion in the second quarter of fiscal year 2026 (Q2FY26), reflecting a year-on-year increase of $7.238 billion, or 5.54%, compared to $130.773 billion at the end of Q2FY25. At the same time, debt servicing payments surged to $4.07 billion in Q2FY26, up from $3.55 billion in the preceding quarter. These figures are not merely statistical entries in official reports; they represent mounting pressure on an already fragile economy and a growing burden on the people of Pakistan.

External debt accumulation is not new to Pakistan. For decades, successive governments have relied on foreign borrowing to finance external payments, bridge fiscal deficits, fund development projects and stabilise foreign exchange reserves. However, in recent years, the pace and sustainability of this borrowing have become serious concerns. The increase to $138.01 billion indicates that reliance on external financing remains substantial. While some borrowing may be justified for economic development, the real issue lies in the effective utilisation of funds and the ability to generate sufficient foreign exchange to service these liabilities.

Rising debt servicing is particularly alarming, reaching $4.07 billion in Q2FY26 compared to $3.55 billion in the preceding quarter. These payments are made in US dollars, placing pressure on foreign exchange reserves and the exchange rate. When reserves are low, the central bank is compelled to allow currency depreciation. Although the State Bank of Pakistan is currently managing the rupee tightly against the dollar, an artificially stable currency hurts exports, widens the trade deficit and increases the likelihood of returning to another IIMF programme – perpetuating a vicious cycle of debt.

The business community is directly affected by rising external debt and servicing obligations. As repayments increase, the government often responds by tightening fiscal policies, raising taxes or cutting development spending. These measures translate into higher costs for businesses and reduced economic activity. High debt servicing crowds out productive investment, and Pakistan is already facing one of the lowest investment-to-GDP ratios in the region. Instead of allocating resources to industrial expansion, export incentives, infrastructure or energy reforms, a large share of the budget is diverted toward servicing past loans. This weakens growth prospects and erodes investor confidence.

Heavy reliance on external financing also brings stringent conditions from lenders, as seen in the ongoing IMF programme. These conditions often include subsidy cuts, higher energy tariffs, increased taxation and exchange rate adjustments. While some reforms are necessary, abrupt policy shifts disrupt business planning and reduce competitiveness in domestic and international markets, worsening the trade deficit and intensifying challenges faced by exporters.

The burden of rising debt is not confined to government accounts; it is ultimately borne by the public. Increased taxation, inflation and currency depreciation erode purchasing power. When debt servicing consumes a large share of national revenue, fewer resources remain available for health, education and social protection. Access to basic necessities, such as safe drinking water, remains limited across many parts of the country, reflecting the broader impact of fiscal constraints.

Currency depreciation, often triggered by external imbalances, raises import costs, particularly for essential goods. Given Pakistan’s dependence on imported fuel, machinery and commodities, depreciation fuels inflation. The result is a higher cost of living for ordinary citizens, exacerbating economic hardship and pushing more households into poverty.

The root causes of Pakistan’s external debt problem lie in structural weaknesses. The export base remains narrow, dependent on a limited range of products and markets, primarily textiles and rice. Despite potential in information technology, agriculture value addition, engineering goods and minerals, diversification efforts have been insufficient. Similarly, tax collection remains below potential due to a narrow base and inefficiencies in documentation. Despite tax revenues growing over the past decade, government expenditures continue to exceed revenues, leading to a sharp rise in public debt. Without meaningful tax reforms and expenditure rationalisation, borrowing becomes the default option.

Energy sector inefficiencies and circular debt further compound the problem. Loss-making state-owned enterprises and persistent subsidies strain public finances. Instead of contributing to growth, many public entities have become financial liabilities.

The situation, though serious, is not beyond remedy. It requires bold, sustained policy measures rather than short-term fixes. Pakistan must prioritise export-led growth through diversification, value addition and improved competitiveness. Trade policies should be liberalised, customs procedures reformed and restrictions on exporting imported goods removed. Incentivising technology adoption, improving logistics and ensuring policy consistency can help exporters access new markets, particularly in the regional economy.

Expanding the tax base and ensuring equitable taxation are equally critical. A broader tax net would reduce reliance on indirect taxes that disproportionately affect lower-income groups. Digitisation and transparency can improve compliance, while competitive tax rates can attract foreign direct investment and reduce capital flight. Fiscal discipline is essential. Rationalising non-development expenditure, improving public sector efficiency and focusing development spending on productivity-enhancing projects can help contain deficits.

Reforms in the energy sector are vital to address circular debt, reduce transmission losses and improve governance. Encouraging domestic savings through financial sector reforms can reduce reliance on external borrowing. Attracting investment into productive sectors, rather than depending on loans, will improve the balance of payments. Prudent debt management, including setting limits on debt-to-GDP ratios, lengthening maturities and enhancing transparency, can reduce risks.

The rise in external debt to $138.01 billion and quarterly servicing of $4.07 billion should serve as a wake-up call. Policymakers, businesses and civil society must act collectively to steer the economy towards sustainability. The private sector is ready to invest and expand, but it requires a stable macroeconomic environment and consistent policies.

Pakistan has immense potential, with a strategic location, a young population and abundant resources. Harnessing this potential requires clear vision and disciplined execution. If decisive steps are taken now, the country can reduce dependence on external borrowing and build a resilient economy. Otherwise, rising debt will continue to constrain growth and burden future generations. The time for structural reform is not tomorrow; it is today.

THE WRITER IS A FORMER VICE PRESIDENT OF KCCI, AN INDEPENDENT ECONOMIC ANALYST FOCUSING ON GLOBAL TRADE, ENERGY ECONOMICS AND GEOPOLITICAL RISK