The central government debt increased to Rs48.4 trillion in August 2024, 21 percent higher than the same period last year. However, the debt-to-GDP ratio has decreased from 74 percent to 66 percent. This paradox—rising debt alongside a falling debt-to-GDP ratio—can be attributed to inflation outpacing debt growth, implying that the improved debt numbers come at the cost of diminishing purchasing power.

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

It’s important to note that central public debt figures do not include substantial government unfunded pension liabilities, which stand at Rs11 trillion for Punjab alone. The total federal (including military) and provincial pension liabilities are estimated to be around Rs30–35 trillion, exceeding the country’s total external debt.

Therefore, there is little cause for celebration regarding the improved debt-to-GDP ratio, as it excludes all liabilities the state faces, and the reduction is primarily due to high inflation. As inflation subsides, the debt-to-GDP ratio may not continue to decline at the same pace.

The immediate priority should be to reduce the government’s fiscal deficit in the short term and the primary fiscal deficit in the medium term. However, domestic debt servicing may not decrease as quickly as inflation because debt repricing takes time, and the SBP is likely to maintain high real positive interest rates.

A key focus for the government should be to reprofile domestic debt, as rerolling and repricing risks have increased, with the majority of market debt concentrated in T-Bills and floating-rate Pakistan Investment Bonds (PIBs), including their Islamic counterparts.

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 significantly 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.

If the government had accumulated more fixed-rate PIBs, particularly for 10 years or longer, the debt servicing burden in the last two years could have been lower. For example, fixed PIB yields rose 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.

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

With interest rates now on a downward trajectory, this is an opportune time for the government to shift its debt profile towards long-term fixed-rate instruments to build resilience against future crises, where inflation and interest rates may surge again.

Currently, 10-year PIB secondary market yields are hovering around 12 percent, close to the yield on similar tenure papers the government already holds. The government should continue issuing more long-term fixed-rate bonds until interest rates bottom out.

Increasing the share of long-term fixed bonds will improve the yield curve, foster a market for pension funds, and support long-term lending for private sector projects and much-needed housing mortgages.