When a borrower is compelled to take out additional loans just to pay back their current ones, this is known as a debt trap.
To put it simply, a debt trap is when financial commitments exceed one’s ability to repay loans. Over a defined period of time, loans are returned in two parts: the principal and interest.
It is not always the case that high-priced or costly loans are the only source of a debt trap. A large loan can be easily repaid if the borrower has a sufficient income. As a result, the loan amount is not always equivalent to a debt trap.
In this case, the borrower might ultimately take out a new loan to pay back the old one. If the borrower is unable to make timely repayments and the interest component continues to rise each month, a little loan could also put them in a debt trap.
There are further causes for inadvertent debt accumulation. For instance, to get through an urgent situation, someone might have taken out a costly short-term loan. Or someone might have taken out a minor loan but abruptly lost the ability to pay it back because they lost their employment.
Occasionally, a borrower may have delayed paying off their entire loan in the hopes of doing so once they have received payments that are owed to them and have more money available. However, they wind up defaulting on their financial obligations if their ideas fail to come to fruition.
Because it has several ramifications, avoiding a debt trap is essential. In addition to negative effects on finances and credit scores, it can cause major social and psychological problems.
Therefore, in order to avoid being caught in a debt cycle, effective money management and on-time repayments are essential.
The state of Pakistan is also dealing with the debt trap. since its inception Pakistan has followed the dependence economic model. According to data released by the State Bank of Pakistan (SBP), as of June 30, 2024, Pakistan’s total public debt, including both external and domestic debt, was an astounding PKR 71 trillion, or 67% of its GDP.
It is concerning to note that, according to the Finance Ministry (2024), half of the fiscal budget for the current fiscal year (FY25) would be allocated to debt servicing and interest payments, leaving less than half of the funds available for public sector development, health, education, defense, energy, and agriculture.
The 25th IMF bailout program, worth USD 7 billion (IMF-2024), was recently entered by the nation, which would make the burden of debt payment even more severe in the years to come.
Debt profile: According to SBP-2024, Pakistan’s debt profile is made up of PKR 22 trillion (31%), or PKR 47 trillion (66%), in external and domestic debt.
As of July 2024 (SBP-2024), the issued long-term government securities—Pakistan Investment Bonds valued at PKR 28 trillion and short-term Market Treasury Bills valued at PKR 11 trillion—account for the majority of the country’s debt.
The foreign debt, on the other hand, is mostly long-term and owed to the Paris Club, bilateral creditors, and multilateral creditors. However, as maturities draw near in the upcoming years, a sizable amount of the long-term debt will convert to short-term debt.
To effectively address the debt crisis the following actions could steer the country out of this malaise. First, debt restructuring is necessary Pakistan must renegotiate its debt with domestic and external lenders.
Second tax base must be broadened, and exports must be augmented. As there is dire need that Pakistan should diversify its trade base as this is the only way to stabilize the economy in Pakistan.
