Foreign Debt: The Main Hurdle in Pakistan's Economic Growth

"A nation that lives on borrowed money cannot live with dignity for long." This single line explains Pakistan's economic story. For almost seven decades, Pakistan has survived from one loan to another — from the IMF, the World Bank, the Paris Club, friendly countries and commercial bonds. Debt was supposed to be a bridge to growth. In Pakistan's case, it has become a wall in front of growth. Today, Pakistan does not borrow to earn; it borrows to repay. Every year, a major part of the budget goes not to schools, hospitals or roads, but to paying back old loans and their interest. This is the classic definition of a debt trap. Foreign debt is therefore not just an economic issue; it is a question of sovereignty, development and the future of 240 million people.

Stability has returned, the burden has not

In 2026, the picture is mixed — stability has returned, but the burden has not gone. According to the Ministry of Economic Affairs, as of 30 June 2026, Pakistan's total external public debt stood at $98.07 billion. During FY 2025-26 alone, Pakistan repaid $14.44 billion in external debt servicing — $11.19 billion principal plus $3.23 billion interest. In simple words, Pakistan paid more in interest in one year than the total annual budget of many small countries. If domestic debt is also included, the total debt and liabilities of the country rose to Rs 99.6 trillion in FY 2025-26, with public debt accounting for about 87 percent of the total. The federal government's debt alone crossed Rs 83.64 trillion by June 2026.

At the same time, there is some good news. Pakistan avoided default. The State Bank's foreign exchange reserves reached $18.4 billion at the end of FY 2025-26, remittances hit a record $41.6 billion, and inflation which was 38 percent in May 2023 came down to 3.2 percent by June 2025. Because of this stabilisation, Moody's upgraded Pakistan from Caa1 to B3 in August 2026, citing improved governance, stronger reserves and sustained macroeconomic stabilisation. S&P also raised Pakistan to B, and Fitch to B-. But this upgrade is a journey from "very high risk" to "high risk", not freedom. It only means Pakistan is now considered less likely to default — not that it is out of debt.

Why the debt keeps growing

The causes of this rising debt are deep and old. The first cause is the declining industrial and export performance. Pakistan's exports remain stuck around $30 to $32 billion and are dominated by low-value textiles. We import machinery, oil and technology, but export cotton and rice, and this trade gap is always filled by loans. The second cause is weak and slow economic growth. Growth remained only 2.7 percent in FY 2024-25 and the target for FY 2025-26 was only 4.2 percent. When an economy grows slower than its interest rate, debt automatically grows.

The third cause is the collapse of the agriculture sector. Floods of 2022 and 2025, climate shocks, water shortage and expensive fertiliser have destroyed the backbone of the economy. A country that was once an agricultural exporter now imports wheat and cotton. The fourth cause is the over-expansion of government spending. The total federal outlay for FY 2025-26 was Rs 17.57 trillion while revenue was far less, and this gap is always filled by borrowing. The fifth cause is low tax collection. Even after the FBR achieved its revised target of Rs 13.0 trillion in FY26, the tax-to-GDP ratio remains around 11 percent, one of the lowest in the region.

The sixth cause is loss-making state-owned enterprises. PIA, Pakistan Steel Mills, Railways and DISCOs eat hundreds of billions every year, and their losses finally become government debt. The seventh cause is the high cost of doing business. Expensive electricity, gas and high interest rates make Pakistani goods uncompetitive. Investors leave, exports fall and loans rise. The eighth cause is dependence on IMF programmes. Pakistan is currently under a $7 billion Extended Fund Facility approved in September 2024. Every IMF programme brings discipline, but also new conditions and new loans to repay old loans. The ninth cause is high defence spending. Defence allocation was raised by 20 percent to Rs 2.55 trillion in FY 2025-26, and with military pensions this figure rises to Rs 3.29 trillion. Security is a genuine need, but after that little is left for development.

The non-structural drivers

Along with these, there are some non-structural causes which make the debt even bigger. Rapid population growth, which according to Census 2023 is 241.49 million and growing at more than 2 percent per year, demands new schools, jobs, food and energy every year, and all of this is financed by debt. Rising unemployment, frequent natural disasters, bad governance, rampant corruption and political instability have made the situation worse. Short-lived governments take loans for short-term popularity, but no government owns the long-term repayment. The widening digital divide and growing terrorism in KP and Balochistan have not only increased security spending but have also frightened away foreign investment, which is the only real alternative to debt.

Short-term relief, long-term cost

The impacts of foreign debt are also of two types. In the short run, debt has some benefits. It boosts foreign exchange reserves, supports government spending, stabilises the rupee and buys time for reforms. Without IMF and friendly-country deposits, Pakistan would have defaulted in 2023.

But in the long run, its disadvantages are far greater. In FY26, Pakistan received $16.16 billion but repaid $14.44 billion, which means new money is being taken only to pay old money. Debt servicing consumed nearly 47 percent of total federal outlay in FY 2025-26, and when half the budget goes to lenders, how can growth happen? A country which needs IMF approval for its budget cannot make fully independent decisions. To pay debt, the government raises taxes and removes subsidies, which increases inflation, reduces investment in education, lowers health spending, leaves infrastructure poor, creates social unrest and increases brain drain. The best minds leave the country because the state has no money left to employ them.

Earning, not borrowing: the way out

What is the solution? Pakistan does not need more loans; it needs more earning capacity.

First, the tax base must be broadened. Retailers, agricultural income and real estate must be brought into the tax net through digitalisation, and the burden must not be put only on the salaried class. Second, institutional reforms and privatisation of loss-making enterprises must be carried out; every privatised PIA or Steel Mill will close one hole in the budget. Third, strict anti-corruption measures must be taken and public procurement must be made transparent, because corruption is a hidden tax on growth.

Fourth, exports must be diversified. Pakistan must move from raw cotton to IT, software, pharmaceuticals and value-added textiles; IT exports alone can bring $5 to $10 billion without any loan. Fifth, agriculture and industry must be modernised: drip irrigation, climate-resilient seeds and solar-powered tubewells can revive agriculture. Sixth, tourism must be promoted and CPEC must be completed on time. Northern Pakistan, Mohenjo-Daro and religious tourism hold untapped dollars, and CPEC Phase-II must focus on industrial zones, not just roads.

Seventh, climate control measures and awareness about population control are necessary. Climate adaptation is cheaper than climate disaster, and population control is not a slogan but an economic necessity. Finally, insurgency must be combated and the political environment must be stabilised, because no investor invests in a country where policies change with every government. Political stability is the cheapest economic reform.

Stabilisation is not liberation

In the end, it can be said that foreign debt is not Pakistan's destiny; it is Pakistan's habit. For 75 years we have chosen the easy path of borrowing over the hard path of earning. The upgrade to B3 proves that when Pakistan follows discipline, it can stabilise. But stabilisation is not liberation. True liberation will come only when Pakistan earns more than it spends, exports more than it imports, and taxes fairly instead of borrowing endlessly. If Pakistan does not break this cycle now, the next generation will not inherit a country; it will inherit a bill.