A Nation in Distress: Reality of Pakistan’s Economic Crisis
Posted at 9-February-2023 / Written by Rohit Bhatt
Pakistan is currently facing a grave economic crisis with rising inflation, depleting foreign exchange reserves, and dependence on imports. In May 2022, the government took measures to control inflation and stabilise the economy, including banning the import of luxury items, lifting the cap on fuel prices, and reducing tea consumption. Despite these efforts, the country continues to struggle with inflation reaching 21.3% in June, the highest since 2008. Additionally, the 2022 summer floods resulted in over $30 billion in economic losses, further exacerbating the crisis.
The depreciation of the rupee and the consistent decline of the State Bank of Pakistan’s reserves are also contributing to the economic turmoil. In January 2023, even the CEO of Pakistan's largest bank commented on the dire situation, warning of a potential collapse if swift action is not taken. The government unveiled a new federal budget in June 2022. Still, with the current debt at 247 billion dollars and only 3.7 billion in foreign exchange reserves, the 6 billion bailouts from the IMF may not be enough to save the country from economic collapse. Let's dive deep into the situation and explore the reasons behind this crisis and possible solutions to overcome it.
The reason behind Pakistan worsening economic crisis
The Pakistani economy has been pushed to a perilous state due to a multitude of reasons, each of which has its own significant impact. Let's take a closer look at each one of these reasons and understand why they have led to the current state of the Pakistani economy.
Debt: Pakistan's total external debt stocks have increased to $130.433 billion by end-2021 from $115.695 by end-2020, as reported by the World Bank. The country's external debt reached $126.9 billion in September 2022, according to CEIC data. Currently, Pakistan's debt-to-GDP ratio is in a danger zone of 70 percent, with 40-50 percent of government revenue earmarked for interest payments this year, according to Reuters. Out of the country's $27 billion in bilateral debt, approximately $23 billion is made up of Chinese loans, as reported by Mint.
Inflation: Inflation in Pakistan was at a 48-year-high in January, as thousands of containers of food items, raw materials, and equipment are stuck in ports after the cash-strapped government curtailed imports, as reported by Bloomberg. The inflation rate worsened to 27.55 percent recently. Higher inflation has a depressing effect on the value of a country's currency, as it reduces the currency's buying power and weakens it against other currencies. This brings us to the concern about the Pakistani rupee.
The Pakistani Rupee: The Pakistani rupee fell 9.6 percent against the dollar on January 26, the biggest one-day drop in over two decades, which may persuade the International Monetary Fund to resume lending to the country, according to Reuters. Last week, Pakistan removed an artificial cap on the rupee, resulting in it losing 14.73 percent in interbank trading during the last three trading sessions.
Foreign Exchange Reserves: In January of this year, Pakistan's foreign exchange reserves dropped to $4.3 billion, the lowest since 2014, according to an Aljazeera report. The State Bank of Pakistan (SBP) announced this after paying off some of the country's external debt payments. Commercial banks hold $5.8 billion, totalling nearly $10.1 billion, and the total liquid foreign reserves held by the country stood at $9.45 billion as of January 20, 2023, according to the SBP report.
Political Crises: It is believed that constant political chaos may undermine a coherent and timely policy response. No Pakistani PM has completed a full five-year term in office, and the current government's tenure will end in August, enabling a special caretaker government to take charge for up to 90 days in a bid to ensure free and fair elections. However, the caretaker government is not empowered to sign an IMF (International Monetary Fund) pact, raising the question of whether the government and opposition can cooperate on a joint pledge to push through any IMF demands in order to avert a default, as reported by Reuters.
Shortage of Power and Energy: Pakistan is highly import-dependent, particularly with regard to energy, which renders it acutely vulnerable to hikes in global oil and gas prices, according to John Ciorciari, Professor and Associate Dean for Research and Policy Engagement at the University of Michigan. The recent massive outage has added to the country's woes. Although Pakistan has enough installed power capacity, it lacks the resources to run its oil-and-gas-powered plants, which are heavily in debt and cannot afford to invest in infrastructure and power lines. The crisis has forced the government to order shopping malls and markets to close by 8.30 pm for energy conservation purposes, according to an IANS report.
Devastating floods: Pakistan's economy was in the process of recovering from the effects of COVID-19. To make matters worse, recent devastating floods have further delayed the much-needed economic adjustment in the country. The World Bank has stated that the economic impacts of the floods might have delayed the "much-needed economic adjustment" and that the growth in Pakistan's economy is expected to reach only around 2 per cent in FY23.
Tense relations with India: The strained relations between Pakistan and India continue to hinder the country's potential for growth through transformative trade and investment partnerships. Despite a slight increase in bilateral trade, reaching $514 million in 2021-2022 according to the Ministry of Commerce, Indian exports still outweigh imports from Pakistan. Unfortunately, terrorism originating from territories under Pakistani control remains a significant issue in their relationship, as stated by the Ministry of Commerce in 2020. This ongoing tension between the two nations continues to hinder their potential for economic prosperity and stability.
Pakistan's Past Economic Policies
Pakistan's past attempts to tackle its economic woes have been marked by a reliance on borrowing without implementing the necessary reforms to address underlying issues. This has led to the country's accumulation of debt to countries like China and Saudi Arabia, with its largest creditor now having a total exposure of over $25 billion. Additionally, the utilization of monetary policy through interest rate hikes and a focus on the exchange rate as a solution have proven to be ineffective, with little to no impact on aggregate demand, inflation, or real output.
Pakistan's current economic crisis requires immediate action to both stop the continued loss of foreign exchange reserves and the devaluation of the rupee, as well as to address the fundamental reasons for these recurring issues. The conventional thinking of local and foreign experts has failed to bring about real change, and it's time to look towards more innovative solutions to get the country's economy back on track.
Pakistan is facing an economic crisis with rising inflation, depleting foreign exchange reserves, and high import dependency. Despite the government's efforts to control inflation and stabilise the economy, the country continues to struggle. The reasons behind the crisis include a high debt-to-GDP ratio, a weakening Pakistani rupee, low foreign exchange reserves, political instability, shortage of power and energy, devastating floods, and tense relations with India.
The government has announced a new federal budget, but with current debt at $247 billion and only $3.7 billion in foreign exchange reserves, a $6 billion bailout from the IMF may not be enough to save the country from an economic collapse. To overcome this crisis, swift and unified action from the government and opposition is needed, along with an effective policy response and investments in infrastructure and power.