Key Takeaways
- Pakistan's government issued a massive amount of floating-rate debt instruments to manage inflation.
- The debt portfolio's Average Time to Maturity is near 3.9 years, with 70% of it being floating rate.
- Inflationary expectations and monetary policy measures affect the government's fiscal burden.
Amid the post-Covid-19 inflationary spiral, Pakistan's government has become increasingly dependent on the domestic debt market to finance its massive deficits. The total cumulative issuance of semi-annual floating Pakistan Investment Bonds increased from less than Rs1 trillion in 2020 to more than Rs22 trillion by 2024.
The debt portfolio's Average Time to Maturity (ATM) is near 3.9 years, while Average Time to Refix (ATR) stands just above one year. This leads to a vicious cycle of repricing, where price increases immediately upset fiscal accounts.
The conventional economic theory suggests that price spirals are the result of excess aggregate demand, which the State Bank of Pakistan can tame by raising interest rates. However, Pakistan faces high cost-push, structural, and import-driven inflation. The recurring price spirals are mainly on the supply side, resulting from sudden currency devaluation, global commodity shocks, frequent revisions of administered energy tariffs, and domestic food supply bottlenecks.
The central bank's rate hikes to tackle price shocks reprices the government's huge domestic floating debt stock. This means that the policy rate hikes get quickly and vigorously passed on through the sovereign debt portfolio to fiscal expenditures. The costs of servicing the debt take up a large share of the federal budget, consuming 40 per cent of the federal budget despite three consecutive years of contractionary fiscal policy delivering consistent primary surpluses.
The government had no choice but to cut development spending and investment in productive capital. An anti-price policy, used to control prices, ends up increasing fiscal pressure, deteriorating the composition of public finances, and consuming public investments that can no longer be used for long-term structural productivity spending.
The Debt Management Office has achieved good results in the past few years, but the structural problem needs to be significantly addressed by improving sovereign debt indicators. The government should continue to work on structural reprofiling to address the sovereign portfolio's repricing sensitivity.
