Impact of Fiscal Deficit Threshold on Economic Growth: Evidence from Pakistan (1985–2025)

Abstract

This paper examines the impact of fiscal deficit on economic growth in Pakistan and identifies the fiscal deficit threshold beyond which economic performance begins to deteriorate. Using annual time-series data from 1985 to 2025, the analysis incorporates GDP growth as the dependent variable and fiscal deficit as the main independent variable, while inflation, investment, and trade openness serve as key macroeconomic controls. Data were sourced from the World Development Indicators (WDI), State Bank of Pakistan (SBP), and Pakistan Economic Survey (PES). The Autoregressive Distributed Lag (ARDL) approach was employed due to the mixed order of integration among variables, allowing for both long-run and short-run estimations. The empirical findings indicate a significant negative long-run relationship between fiscal deficit and economic growth, confirming that persistent and high deficits undermine Pakistan’s growth performance. Through historical fiscal behavior and long-run coefficient analysis, the study identifies a fiscal deficit threshold ranging between 5% and 6% of GDP. Growth remains relatively stable when the deficit stays below this range but declines sharply when it exceeds it. The results further show that inflation negatively affects growth, while investment and trade openness contribute positively, though their effects vary in magnitude. Overall, the study concludes that maintaining fiscal deficits within a sustainable range is crucial for Pakistan’s long-term economic stability. Policy recommendations include strengthening revenue mobilization, reducing unproductive expenditures, improving debt management, and promoting macroeconomic stability. The study contributes updated empirical evidence to the fiscal policy literature and offers practical guidance for policymakers aiming to achieve sustainable economic growth.