ABSTRACT

Most of the developed and emerging economies have the common goal of attaining long-term sustainable and higher economic growth. Domestic and external borrowings are the major sources of financing in these countries. The relationship between economic growth and public debt is not simple and unidirectional. Debt has both positive and negative implications, efficient and productive use of debt fosters economic development, but when used inefficiently and imprudently it impacts economic growth negatively. An increasing number of recent studies support the idea of a non-linear association between public debt (PD) and economic growth, with a threshold level at a certain point, above which excessive public debt adversely affects economic growth. This paper explores the nonlinear debt-growth nexus and estimates the threshold level of total public debt, domestic debt, and external debt for Pakistan and also analyzes the sustainability of public debt. The latest available time series data is utilized for the period 1973-2022. The Heteroskedasticity Consistent Lagrange Multiplier Test and Threshold Regression Model byHansen(1996,2000) are utilized for this purpose. The result reveals a non-linear relationship between public debt and economic growth, estimating the optimal public debt threshold for Pakistan to be around 58.5%. The threshold levels of domestic and external debt are 43.3% and 27.5% respectively. The estimated public debt threshold is in line with the 60% benchmark set by the FRDL Act, 2005. All the forms of debt affect economic growth adversely when the threshold levels are exceeded. Similarly, employing various empirical methods, including the stationarity test, co-integration approach, and fiscal reaction function approach, the study found public debt unsustainable in the country. The fiscal policies in the country are not responding efficiently to the increasing level of debt and the government expenditures are not according to its revenues. The government cannot meet its current financial obligation without additional financial assistance or facing financial distress. Using a debt-dynamic equation, this study simulates future debtto-GDP ratio levels under various growth and fiscal deficit assumptions. The analysis indicates that a high GDP growth rate and lower fiscal deficits are crucial for reaching sustainable debt levels. To ensure sustainability, the study recommends maintaining a growth rate of 5-10% or higher, reducing the fiscal deficit to 1-2% along with efficient fiscal policies, cutting excessive expenditures, and increasing revenues. The implementation of these strategies can foster economic growth and ensure the sustainability of public debt in the country.