Uncertainty and Risk Around Debt Sustainability Analysis of Pakistan: A Fan Chart Approach

Abstract

The debt sustainability has emerged as a critical challenge for many emerging economies, including Pakistan. The fiscal response function (FRF), is the framework to focus on the government’s capability to adjust its fiscal position in react to increasing debt levels. This study fills a critical gap in the current literature by integrating the idea of the primary expenditure gap, demarcated as the deviation of actual primary expenditure from its mean expenditure level. This research paper focuses on fiscal imbalances in Pakistan, which are mostly expenditure-driven, and ignoring this element may lead to lacking or ambiguous conclusions regarding debt sustainability in Pakistan. This research models the primary balance as a function of total public debt, GDP gap, primary expenditure gap and a democracy dummy variable to capture macroeconomic and institutional effects on fiscal policy behavior through ARDL econometric model for the time period of 1976 to 2024. Furthermore, the study employs a fan chart forecasting approach to forecast total public debt, domestic debt, and external debt, incorporating uncertainty and risk into future debt paths. The FRF approach provides an organized method to assess whether fiscal policy in Pakistan gratifies the sustainability condition, while the primary balance responds positively to an increase in public debt. The empirical results of study evaluates whether Pakistan demonstrate a stabilizing fiscal response to public debt and examines the role of cyclical conditions, captured by the GDP gap, primary expenditure gap as well as political regimes insight  through the democracy dummy. The study offers important policy implications for designing effective fiscal consolidation strategies, emphasizing the need to manage primary expenditure alongside improving fiscal responsiveness to ensure long-term debt sustainability in Pakistan.