Inflation as a fiscal problem

Pakistan’s inflation problem has become tightly bound to its fiscal position. After the massive post-Covid-19 inflationary spiral, a government with limited foreign-exchange reserves turned increasingly to the domestic debt market to finance large deficits.

That dependence forced the government to issue substantial volumes of floating-rate, long-term debt instruments as it tried to manage severe rollover risk. Cumulative issuance of semi-annual floating Pakistan Investment Bonds rose from less than Rs1 trillion in 2020 to more than Rs14 trillion in 2024. It now exceeds Rs22 trillion.

Floating-rate instruments make up about 70 per cent of all domestic sovereign debt. The debt portfolio’s average time to maturity is close to 3.9 years, while the average time to refix is just above one year.

Those figures create a rapid repricing cycle. As interest rates and prices move, the cost of servicing government debt can adjust quickly, putting immediate pressure on public finances. Conventional economic theory attributes price spirals to excess aggregate demand, but Pakistan’s experience shows how inflation and fiscal weakness can reinforce each other.