Fiscal Deficits and Public Debt Dynamics in Pakistan: A Cointegration Analysis

Abstract

This study investigates the effects of fiscal deficit on the dimensions of public debt in Pakistan over the period 1972 to 2024. Using annual time series data, three econometric models are specified with domestic debt, external debt, and total debt as dependent variables, and fiscal deficit as the independent variable. The Engle-Granger cointegration technique is applied to examine long-run relationships, while error correction models (ECM) assess short-run dynamics and the speed of adjustment toward equilibrium. Augmented Dickey-Fuller (ADF) unit root tests confirm that all variables are integrated of order one, I(1). Results indicate a statistically significant positive relationship between fiscal deficit and all three dimensions of public debt. A one percent increase in fiscal deficit leads to approximately a 10.27 percent rise in domestic debt, a 1.46 percent rise in external debt, and an 11.73 percent rise in total debt. Error correction estimates reveal that while fiscal deficit adjusts rapidly (within approximately one month), debt variables converge slowly toward equilibrium, requiring approximately one year. Granger causality tests reveal bidirectional causality between domestic debt, external debt, and total debt. These findings suggest that sustained fiscal consolidation, improved tax administration, and reduction of unproductive expenditures are necessary to curtail Pakistan's rising debt burden.