In recent months, concerns have been raised about Pakistan’s debt framework due to funding concerns, delayed IMF reviews, tightening of global liquidity conditions, and continuous fiscal slippages. International credit agencies Moody’s and Fitch have adjusted the country’s credit rating downwards to reflect the inherent risks, leading to increased costs of debt internally and externally. As a result, there is increased market chatter suggesting restructuring of domestic debt, with options like haircut, extensions and reprofiling doing the rounds.

Domestic debt restructuring refers to the process of reorganizing or modifying a
country’s outstanding domestic debt obligations, such as government bonds or treasury bills. This is usually done in response to a country’s inability to
meet its debt obligations, often due to economic challenges or financial
crisis. The goal of domestic debt restructuring is to make the debt more
sustainable and manageable for the government while minimizing the negative impact on the economy and the country’s financial system. Domestic debt
restructuring can have significant implications for the country’s credit
rating, financial stability, and access to international capital markets.

To determine whether Pakistan should undergo domestic debt restructuring to materially ease the debt burden on the economy, three fundamental questions need to be answered:

1.    Is Public Debt to GDP unsustainable or fast approaching those levels? Pakistan’s domestic debt as of December 2022 stands at PKR 33.8trn, which has more than doubled over the past five years while total public debt is set at PKR 52.5trn. The existing debt remains higher than average on both key metrics of debt sustainability, and debt servicing is estimated at close to PKR 5.6trn in FY23. Given the inability of the federal government to expand its revenue base, improve tax administration and recovery, or reduce expenditures, including adequate resolution of loss-making SOEs, the medium to long-term outlook for the fiscal account appears challenging. One potential solution could be to revisit the National Finance Commission (NFC) award distribution, which allocates resources between the federal government and the provinces.

2.    How robust is the financial system to withstand any restructuring exercise? Restructuring can have significant implications for a country’s financial stability, and Pakistan’s financial system needs to be robust enough to withstand any such exercise. Rationalizing federal expenses by keeping only essential federal ministries and transferring other responsibilities to the provinces can help reduce expenses significantly. Implementing a system of monitoring and evaluation for federal and provincial expenses can help ensure that resources are being used effectively and efficiently.

3.    Can we identify and mitigate the social and economic costs? Any restructuring exercise can have social and economic costs that need to be identified and mitigated. Improving provincial surpluses by increasing revenue collection and improving financial management can also play a significant role in reducing the debt burden.

In conclusion, Pakistan’s debt situation is a complex issue that requires careful
consideration of various factors before deciding to undergo domestic debt
restructuring. Revisiting the NFC award distribution, rationalizing federal
expenses, and improving financial management can go a long way in resolving. Pakistan’s rising debt issue, ensuring the country’s financial stability in the long run.