By Qudsia Bano

Prolonged high global interest rates are tightening financial conditions across emerging markets, with Pakistan increasingly feeling the pressure as external financing needs rise and capital flows remain volatile.

According to the International Monetary Fund, Pakistan’s economy is projected to grow by around 3.6% in 2026, while inflation is expected to hover near 7.2%, reflecting a still-fragile macroeconomic recovery under persistently tight global monetary conditions. The Fund has also cautioned that elevated borrowing costs and global uncertainty could constrain capital inflows and complicate external financing for developing economies.

Pakistan’s own financing requirements highlight these vulnerabilities. The IMF estimates the country’s gross external financing needs at approximately $19.4 billion for fiscal year 2025-26, equivalent to 4.6% of GDP, underscoring continued reliance on external funding. Meanwhile, total external debt has risen to about $138 billion by late 2025, increasing exposure to higher global rates and refinancing risks.

The cost of servicing this debt is already mounting. Official data shows that external public debt interest payments surged from $1.99 billion in FY2022 to $3.59 billion in FY2025 — an increase of more than 80%. This reflects both accumulated liabilities and the global shift toward higher interest rates, a trend analysts expect to persist as advanced economies maintain restrictive monetary policies.

Capital inflows remain uneven. Although foreign assistance rose by over 25% to $4.5 billion in the first half of FY2026, much of the increase came from multilateral and programme-based support rather than private investment, pointing to weakened investor confidence. Monthly trends also reveal volatility, with intermittent negative flows highlighting the fragility of external financing.

To support foreign exchange reserves, Pakistan has increasingly relied on bilateral assistance. Saudi Arabia recently committed an additional $3 billion deposit, supplementing existing arrangements aimed at stabilizing reserves during a period of tight global liquidity. However, economists caution that such measures provide only temporary relief and cannot replace sustained foreign direct investment or market-based inflows.

The broader global environment remains challenging. According to IMF assessments, capital flows to emerging markets have become more selective and volatile, as higher interest rates in advanced economies draw liquidity away from riskier destinations. Consequently, many developing countries are shifting toward domestic borrowing or short-term bilateral financing.

Against this backdrop, Pakistan faces a delicate policy balance: maintaining tight monetary conditions to control inflation while ensuring sufficient liquidity to sustain economic activity and investment.

Aamir Qureshi, Senior Manager Treasury at Meezan Bank Limited, said global interest rate trends are directly affecting Pakistan’s access to international capital markets. Higher yields in the United States and Europe, he noted, are diverting institutional investment away from emerging markets, raising the cost of issuing Eurobonds or securing commercial loans. As a result, Pakistan is becoming increasingly dependent on multilateral lenders and bilateral partners.

He added that this shift is reshaping the country’s debt profile, with growing reliance on shorter-term and conditional financing. While such arrangements help stabilize reserves in the near term, they increase rollover risks and constrain fiscal flexibility. Without improvements in sovereign risk indicators and credit ratings, he said, Pakistan’s return to global capital markets is likely to remain costly.

Daniyal Ahmed, Assistant Manager Investment Strategy at Arif Habib Limited, pointed out that persistently high global rates are also dampening foreign direct investment. Investors now demand higher returns to match elevated global benchmarks, raising the threshold for investment in emerging markets — particularly in capital-intensive sectors such as energy and infrastructure.

He emphasized that Pakistan must strengthen domestic fundamentals to attract more stable inflows. Improving regulatory frameworks, ensuring exchange rate stability, and offering targeted incentives for export-oriented sectors could help offset the impact of global monetary tightening. Without such reforms, he warned, Pakistan risks remaining reliant on short-term financing and exposed to external shocks.

As global interest rates remain elevated, Pakistan’s economic strategy is being tested across multiple fronts — from debt sustainability to investment flows. The coming years will be critical in determining whether the country can transition from dependence on external support toward a more resilient, investment-led growth model.

Credit: INP-WealthPk