It is remarkable that from a situation of default and unsustainable fiscal and balance of payments deficit only a few years back, Pakistan has come out of the debt trap, balance of payments turned surplus1, and fiscal deficit has declined below 4 percent of GDP. However, sharp increase in the inflation rate, widening trade deficit and re-emergence of balance of payments deficit in the current year are quite worrisome. With the widening of the balance of payments deficit and the possibility that fiscal deficit may start rising as the government provides for the higher levels of public expenditure, would the debt problem not emerge once again? Bilquees (2003) has examined the growth of debt over the 1980-81 to 2002-03 period by de-composing the effect of primary deficit, interest rates and exchange rate adjustments. She argues that primary deficits are basic to the growth of debt. Higher government public expenditure compared to its resources leads to higher domestic as well as external borrowings. The external borrowing with limited repayment capacity results in exchange rate depreciation with consequent implications for the debt. The differential between interest rates and growth of GDP also have implications for the debt but in Pakistan it did not result in rising debt ratio because the interest rates have always remained lower than the growth rate.