By Joanne Chiu and Jing Yang

Hong Kong's government is leading a bailout of the city's flagship carrier Cathay Pacific Airways Ltd., providing it with the bulk of a $5 billion funding package that could also give the government a minority stake in the 73-year-old company.

Cathay said Tuesday that it would receive $2.5 billion from a government-owned entity called Aviation 2020 Ltd., which will buy preference shares in the company. The carrier will also be able to draw from a $1 billion bridge-loan facility from the same entity at a low interest rate.

Cathay will separately raise $1.5 billion by selling new shares, and its biggest shareholders, Swire Pacific Ltd., Air China Ltd. and Qatar Airways Co., have committed to subscribe to the rights issue.

Augustus Tang, Cathay's chief executive, said the company turned to the government for assistance after the coronavirus pandemic hammered its business and caused its passenger numbers to drop by more than 99% from a year ago.

Chairman Patrick Healy said the carrier was facing the prospect of collapse and that the deal is critical to Cathay's survival.

Cathay's Hong Kong-listed shares have fallen 23% in the year to date, giving the company a market capitalization of $4.5 billion. They were suspended Tuesday and will resume trading Wednesday.

The government could end up owning 6.08% of Cathay's common shares following the recapitalization, if Aviation 2020 also exercises warrants for about $250 million in additional shares.

Swire, the Hong Kong conglomerate, would continue to be the airline's controlling shareholder, though its stake would be reduced slightly to 42.26% from 45%. Air China's stake would drop to 28.17% from just under 30%, and Qatar's shareholding would also fall slightly. The plan is subject to shareholder approval.

The government intends to appoint two people to attend Cathay's board meetings as observers. They wouldn't have voting rights, but their presence at board meetings could give the government some say in how the company is run.

That arrangement could reduce the airline's autonomy at a time of political instability for Hong Kong and many businesses, which have been under pressure to denounce pro-democracy protests and more recently, to support Beijing's plans to impose national-security laws on the city.

Cathay, like many airlines around the world, has been bleeding cash and reeling from the effects of the coronavirus pandemic, which grounded most of its international and regional flights.

The company last month said its full-service airlines Cathay Pacific and Cathay Dragon together lost $581 million from January to April this year, and described the financial outlook as "very bleak" for the coming few months.

In April, Cathay carried just 13,729 passengers -- or fewer than 500 a day -- versus about 3.1 million passengers in the same month a year ago. With border closures and mandatory quarantines in many countries, Cathay's two airlines plied just 14 destinations, and most of its passengers were Hong Kong residents returning to the city from North America and the U.K.

"Cathay Pacific has explored available options and believes that a recapitalization is required to ensure it has sufficient liquidity to weather this current crisis," the company said Tuesday. It added it had also considered the costs and benefits of different fundraising alternatives.

Despite earlier cost-cutting measures that included cutting executives' pay, asking workers to take voluntary leave and deferring aircraft purchases, Cathay said it has been losing cash at a rate of $323 million to $387 million a month since February.

The company said it intends to implement a further round of executive pay cuts and furlough more employees, as well as re-evaluate all aspects of its business model in the longer term. Cathay's workforce totaled more than 27,000 at the end of 2019.

Governments around the world have spent heavily to keep airlines afloat. In May, the International Air Transport Association said governments had committed $123 billion in financial aid to airlines -- including wage subsidies, equity financing, and tax relief -- of which $67 billion would need to be repaid.

In the U.S., airlines have received $25 billion in federal stimulus money, while in Europe, Germany has agreed a near-$10 billion bailout package for Deutsche Lufthansa AG.

Before the pandemic-induced crisis, Cathay Pacific was already pressured by months of social unrest in Hong Kong, which led to a drop in tourists and business travelers to the city.

The company was also embroiled in controversy after some of its employees took part in antigovernment protests, which drew ire from Beijing and ultimately led to the resignation of senior executives including chief executive Rupert Hogg.

The Hong Kong government will receive dividends and interest payments from Cathay while it is invested in the company.

Cathay will have to pay a 3% dividend, or $75 million a year initially, on the government's preference shares. The dividend increases after three years and tops out at 9% after five years. The $1 billion loan, if drawn upon, would be secured by some of Cathay's aircraft and incur annual interest of 1.5 percentage points over a Hong Kong interbank offered rate. Morgan Stanley was listed as Cathay's sole financial adviser.

Hong Kong Financial Secretary Paul Chan said Tuesday that the government doesn't intend to become a long-term shareholder of the company. "It is not our intention to interfere with the operations and management of Cathay," he added.

Mr. Chan said Cathay is facing a challenge that, if not properly addressed, could harm Hong Kong's status as international aviation hub and affect other economic activities.

"Without the support of governments, it is indeed very difficult during this time for any airline to go to the private market to seek funding," he said.

Write to Joanne Chiu at joanne.chiu@wsj.com and Jing Yang at Jing.Yang@wsj.com