PAKISTAN ECONOMY ON THE EDGE OF COLLAPSE: EFFORTS TO NAVIGATE

 PAKISTAN ECONOMY ON THE EDGE OF COLLAPSE: EFFORTS TO NAVIGATE

INTRODUCTION

  Pakistan is experiencing severe economic challenges reflecting long-standing structural weaknesses. Pakistan made significant progress towards reducing poverty between 2001 and 2018 when the expansion of off-farm economic opportunities and increased inflow of remittances allowed over 47 million Pakistanis to rise out of poverty. However, this rapid poverty reduction has not fully translated into improved socio-economic conditions, as human capital outcomes have remained poor and stagnant, with high levels of inhibiting at 38 $ and learning poverty at 75 $. In addition, reflecting a consumption-driven growth model, with limited productivity-enhancing investment and exports, strong economic growth often comes at a cost of economic imbalances and frequent macroeconomic crises. Long-term growth of real gross domestic product (GDP) per capita, therefore, has been low, averaging only around 2.2 $ annually over 2000-22. Pakistan's economy has been unstable for a long. The difference today is that it is now on the brink of collapse. "Over the past two decades, Pakistan has achieved significant poverty reduction, but human development outcomes have lagged, while economic growth has remained volatile and slow," the World Bank said in its report released in October last year. Economic activity has fallen with policy tightening, flood impacts, import controls, high borrowing and fuel costs, low confidence, and protracted policy and political uncertainty. The devastating floods, along with difficulties in securing quality fertilizers and animal feed, have reduced agricultural output and labor opportunities for low-income workers. Similarly, dwindling foreign reserves, import restrictions, flood impacts, high fuel costs, policy uncertainty, and the slowdown in domestic and global demand have affected industry and service sector activity. With the destruction of infrastructure and disrupted access to schools, medical facilities, and sanitation systems, the floods have negatively impacted health and education outcomes, especially for rural areas, potentially affecting long-term human capital accumulation.

Economic growth is expected to slow and remain below

Pakistan’s economy is currently under severe stress with low foreign reserves, a depreciating currency, and high inflation. With high public consumption, economic growth increased substantively above potential in FY22 which led to strong pressures on domestic prices, external and fiscal sectors, the exchange rate, and foreign reserves. These imbalances were exacerbated by the catastrophic flooding in 2022, surging world commodity prices, tightening global financing conditions, and domestic political uncertainty. Furthermore, distortive policy measures, including periods of informal exchange rate restrictions and import controls, delayed the IMF-EFF program, and contributed to creditworthiness downgrades, lower confidence, high yields, and interest payments, and the loss of access to international capital markets.

With mounting debts and soaring inflation, Pakistan continues to pin its hope on the International Monetary Fund (IMF) for a bailout from its deep economic crisis. But the brewing political problem may come in the way of that. What lies ahead for the neighboring country and how it remains unaffected? Caught up in a vicious circle of debt, Pakistan has been spiraling deep into an economic crisis — reviving recent memories of Sri Lanka's financial-cum-political crisis. With the Pakistani rupee falling to a record low and fuel prices shooting up, Pakistan has been struggling to fulfill the basic demands of its citizens, reports claim. But why is Pakistan in such a critical position? What is it doing to climb out of the hole and should India be worried? It is necessary to take a deep dive into the neighboring country's problems and the reverberations around them.

 The country's economy has been pushed to a dangerous level due to numerous reasons. These include:

Debt: According to the World Bank, Pakistan's total external debt stocks increased to $130.433 billion by end-2021 from $115.695 by end-2020. The country's external debt reached $126.9 billion in September 2022, CEIC data revealed. Presently, Pakistan's debt-to-GDP ratio is in a danger zone of 70 $, and 40-50 $ of government revenue is earmarked for interest payments this year, Reuters reported. Out of Pakistan's $27 billion in bilateral debt, around $23 billion is made up of Chinese loans.

Potential in the medium-term. Real GDP growth is expected to slow sharply to 0.4 $ in FY23, reflecting corrective tighter fiscal policy, flood impacts, high inflation, high energy prices, and import controls. Agricultural output is expected to contract for the first time in more than 20 years due to the floods. Industry output is also expected to shrink with supply chain disruptions, weakened confidence, higher borrowing costs, fuel prices, and heightened uncertainty. The lower activity is expected to spill over to the wholesale and transportation services sectors, weighing on services output growth. Predicated on the completion of the IMF program and sound macroeconomic management, output growth is expected to gradually recover in FY24 and FY25 but remain below potential as low foreign reserves and import controls continue to curtail growth. In the absence of higher social spending, the lower middle-income poverty rate is expected to increase to 37.2 $ in FY23. Given poor households’ dependency on agriculture, and small-scale manufacturing and construction activity, they remain vulnerable to economic and climate shocks.

The Government faces a difficult policy challenge in maintaining progress toward macroeconomic stabilization. The economic outlook is dependent on the timely and full implementation of policy reforms, with very high downside risks. Implementing the macro-stabilization measures and structural reforms underpinned by the IMF-EFF program is necessary for unlocking much-needed external refinancing and new disbursements from regional partners. Maintaining stability and a sustained recovery will require the development, communication, and effective implementation of a bold reform strategy, including i) adherence to a flexible market-determined exchange rate and sound fiscal-monetary policies; ii) increased domestic revenue mobilization; iii) curtailing and improving the quality of public expenditures; iv) structural reforms to improve investment, competitiveness, and productivity; and v) urgent measures to restore the financial viability of the energy sector. $153.5m Multi-Donor Trust Fund for conflict-affected areas is being managed by the World Bank

 AROUND THE BANK GROUP

Find out what the Bank Group's branches are doing in Pakistan.

IFC, MIGA 

 Pakistan's Five Areas to Be Watched

tan: Five major issues to watch in 2023

1.        POLITICAL INSTABILITY, POLARIZATION, AND AN ELECTION YEAR

 Politics will likely consume much of Pakistan’s time and attention in 2023, as it did in 2022. The country’s turn to political instability last spring did not end with a dramatic no-confidence vote in parliament last April that ousted then-Pakistani Prime Minister Imran Khan from office. Instability and polarization have only heightened since then: Khan has led a popular opposition movement against the incumbent coalition government and the military, staging a series of large rallies across the country throughout the year. The struggle for power in Pakistan continues into 2023. While the incumbent government has not ceded to Khan’s demand for early elections, country-wide elections are constitutionally mandated to be held by October this year. It benefits the government politically to hold them off as long as it possibly can as it tries to dig itself out of Pakistan’s urgent economic crisis and its lackluster domestic performance (its diplomatic foreign policy approach has fared better, but that may not matter for elections). The last year has cost it precious political capital, and Khan’s party did very well in a set of by-elections held in July and October. The state has tried to mire Khan and his party in legal cases, relying on a familiar playbook used against opposition politicians in Pakistan, albeit to limited effect, with the courts’ involvement. Khan’s party still controls two of Pakistan’s four provinces, Punjab and Khyber Pakhtunkhwa (KP), and the incumbent federal government’s (extra-legal) efforts to try to wrest power from it in Punjab, the largest province, have been unsuccessful (thanks to the courts). The year is off to a dramatic start, with Khan’s party initiating the process to dissolve the Punjab and KP assemblies this month to pressure the federal government into early elections. For politics-obsessed Pakistan, the biggest question remains who will win the next general election? Will former Prime Minister Nawaz Sharif (brother of current Prime Minister Shehbaz Sharif) return to Pakistan to run as the head of his party, the PML-N? Can Imran Khan win on the strength of his popular support, despite his confrontation with the military? Regardless of the outcome, we can say this much given the histories of the main contenders: The direction of the country is unlikely to change.

2.        A PRECARIOUS ECONOMIC SITUATION

 Pakistan’s economy has been in crisis for months, predating the summer’s catastrophic floods. Inflation is backbreaking, the rupee’s value has fallen sharply, and its foreign reserves have now dropped to the precariously low level of $4.3 billion, enough to cover only one month’s worth of imports, raising the possibility of default. An economic crisis comes around every few years in Pakistan, borne out of an economy that doesn’t produce enough and spends too much, and is thus reliant on external debt. Every successive crisis is worse as the debt bill gets larger and payments become due. This year, internal political instability and the flooding catastrophe have worsened it. There is a significant external element to the crisis as well, with rising global food and fuel prices in the wake of Russia’s war in Ukraine. The combination of all these factors has spelled perhaps the greatest economic challenge Pakistan has ever seen. Yet the government has been mired in politicking, and the release of a $1.1 billion loan tranche from the International Monetary Fund (IMF) remains stalled as Islamabad has pushed back on the IMF’s conditions. The government has now resorted to limiting imports and shutting down malls and wedding halls early, small measures that fail to adequately address the problem.

 Pakistan may end up avoiding default for the time being with IMF help and loans from friendly countries, especially Saudi Arabia and other Gulf nations. But those won’t address the clear underlying malaise of the economy – and the fact that something fundamentally will need to change, in terms of how much the economy produces versus how much it spends, to avoid default down the road. But none of Pakistan’s political parties seem to have the political will or ability to bring about such change. Pakistan must reportedly pay back $73 billion by 2025; it won’t be able to do so without debt restructuring.

3.        FLOOD RECOVERY

 A “monsoon on steroids” – directly linked to climate change – caused a summer of flooding in Pakistan so catastrophic that it has repeatedly been described as biblical. It left a third of the country under water – submerging entire villages – killed more than 1,700, destroyed homes, infrastructure, and vast cropland, and left millions displaced. More than four months after the worst of the flooding, nearly 90,000 people are still displaced from their homes, and the floodwater is still standing in some areas. It would be enormously difficult for any country to recover from such a disaster and rebuild lost infrastructure, including roads and schools, let alone a government dealing with a cash crunch like Pakistan’s.

But the Pakistani government – in particular the foreign minister Bilawal Bhutto Zardari, who has visited the United States twice since the summer, and the minister for climate change, Sherry Rehman – has done an admirable job bringing awareness of the flooding catastrophe to the world stage. A donors’ conference Sharif co-hosted with the United Nations Secretary-General Antonio Guterres in Geneva this month raised pledges for more than $9 billion for flood recovery over the next three years (the money is mostly in the form of project loans). Pakistan has also played an important role in discussions about the devastating effects of climate change on developing nations, spearheading the effort to place loss and damage on the agenda at COP27 for the first time, and pushing for COP delegates in Egypt to agree to a loss and damage fund. With billions of dollars in help promised, the government has passed one hurdle. But the road to recovery ahead will be tough: Displaced people are still sleeping under open skies in Sindh province. Implementing a sustainable recovery will require enormous capacity, resources, and transparency in a country already mired in other troubles.

 4.        MOUNTING INSECURITY

 The Pakistani Taliban (or TTP), the terrorist group responsible for killing tens of thousands of Pakistanis from 2007 to 2014, have been emboldened – predictably so – by a Taliban-ruled Afghanistan, and once again pose a threat to Pakistan, albeit in a geographically limited region (for now). The group engaged in at least 150 attacks in Pakistan last year, mostly in the northwest. Because the TTP has sanctuary in Afghanistan, the Pakistani state increasingly finds itself out of options when it comes to dealing effectively with the group. The state’s negotiations with the TTP have failed repeatedly, as they are bound to because the group is fundamentally opposed to the notion of the Pakistani state and constitution as it exists today. The Afghan Taliban have, unsurprisingly, also not proved to be of help in dealing with the TTP – and Pakistan’s relations with the Afghan Taliban have deteriorated significantly at the same time over other issues, including the border dividing the two countries. At this point, Pakistan’s first preference will be to strike kinetically at TTP targets within its borders, but that will be limited by TTP movement across the border into Afghanistan. That movement is what leaves Pakistan with the difficult-to-resolve TTP issue and complicates things beyond the military operation it launched against the group in 2014. Still, the Pakistani Taliban at this point is not the biggest threat Pakistan faces, given the country’s major political and economic challenges – but left unchecked, it could morph into a significant crisis.

 5.        CIVIL-MILITARY RELATIONS

 Pakistan has a new chief of army staff as of November 29 last year. General Asim Munir replaced General Qamar Javed Bajwa, who had held the all-powerful post for six years (due to a three-year extension). The appointment of the army chief was a subject of considerable political contention last year; a major part of the reason Khan was ousted from power was his falling out with the military on questions over the appointments of top army officials.

All eyes are now on how civil-military relations shape up under Munir. Under Bajwa, the military solidified its control over all manner of the policy behind the scenes. Bajwa presided over a close “same-page” relationship with Khan; when that frayed, the PML-N was eager to take Khan’s place as the military’s ally and head of the civilian government. Bajwa left office saying the army would no longer be involved in political matters; few in Pakistan believe him. With politics set to dominate the agenda this year and an election imminent, Munir has a chance to show the country whether he will follow in his predecessor’s footsteps, or chart a new course for civil-military relations in Pakistan. Pakistan’s history indicates the former.  Poor governance and low productivity per capita in comparison with other low to middle-income developing countries have contributed to a balance of payment crisis, where the country is unable to earn enough foreign exchange to fund the imports that it consumes.

 AN EXAMPLE: PAKISTANI WOES

 Muhammad Radaqat, a 27-year-old greengrocer, is worried. He doesn’t know how much onion will cost next week, let alone how he’ll be able to afford the fuel he needs to heat his home and keep his family warm. “All we’re being told by the government is that things are going to get worse,” Radaqat told CNN. His anxiety reflects the mood of a nation racing to ward off an economic meltdown. Faced with a shortage of US dollars, Pakistan only has enough foreign currency in its reserves to pay for three weeks of imports. Thousands of shipping containers are piling up at ports, and the cost of essentials like food and energy is skyrocketing. Long lines are forming at gas stations as prices swing wildly in the country of 220 million. A nationwide power outage last month made people even more alarmed. It brought Pakistan to a standstill, plunging residents into darkness, shutting down transit networks, and forcing hospitals to rely on backup generators. Officials have not identified the cause of the blackout. Muhammad Radaqat, a 27-year-old greengrocer in Islamabad, is worried about whether he can continue to take care of his family.

Pressure is growing on Prime Minister Shehbaz Sharif’s government to unlock billions of dollars in emergency financing from the International Monetary Fund, which sent a delegation to the country this week for talks. Pakistan’s currency, the rupee, recently dropped to new lows against the US dollar after authorities eased currency controls to meet one of the IMF’s lending conditions. The government had been resisting the changes the IMF requested, such as easing fuel subsidies since they would cause fresh price spikes in the short term. “We need the IMF agreement to go through as soon as possible for us to save the ship,” said Maha Rehman, an economist and the former head of analytics at the Centre for Economic Research in Pakistan.

The making of a crisis

Pakistan is experiencing what economists call a balance-of-payments crisis. The country has been spending more on trade than it has brought in, running down its stock of foreign currency and weighing on the rupee’s value. These dynamics make interest payments on debt from foreign lenders even more expensive and push the cost of importing goods higher still, requiring even bigger drawdowns in reserves that compound the distress. The country is also grappling with rampant price increases. The country’s central bank has hiked its key interest rate to 17% in a bid to clamp down on annual consumer inflation of almost 28%. Some issues the country faces are specific to Pakistan. Political instability and efforts to prop up its currency, for example, have weighed on investment and exports, according to Tahir Abbas, head of investment research at Arif Habib, the country’s largest securities brokerage. Historic floods last summer have also led to huge bills for reconstruction and aid, adding to strains on the government budget. The World Bank has estimated that at least $16 billion is needed to cope with damage and losses. Pakistan's usually bustling ports, like this one in Karachi, have ground to a halt as the country grapples with a severe shortage of foreign currency. Yet global factors are making the situation worse. The economic slowdown has weighed on demand for Pakistan’s exports, while a sharp rally in the value of the US dollar last year piled pressure on countries that import significant volumes of food and fuel. Prices for these commodities had already spiked due to the pandemic and Russia’s war in Ukraine, requiring larger outlays.

The IMF has warned repeatedly that this could stress vulnerable economies. While it forecasts that emerging market and developing economies will see a modest uptick in growth this year as the dollar comes off its highs, global inflation falls and China’s reopening spurs demand, the ability to manage debt loads remains a concern. It estimated this week that 15% of low-income countries are already in debt distress, while another 45% are at high risk of struggling to meet their obligations. An additional 25% of emerging market economies are also at high risk. Tunisia, Egypt, and Ghana have all sought IMF bailouts worth billions of dollars in recent months.“ The combination of high debt levels from the pandemic, lower growth, and higher borrowing costs exacerbates the vulnerability of these economies, especially those with significant near-term dollar financing needs,” the IMF wrote in its world economic outlook this week.

No easy fix as suffering grows

For Pakistan to avoid default, talks with the IMF to restart its stalled assistance program must succeed, according to investors and economists. The IMF’s delegation arrived on Tuesday and is set to stay through Feb. 9.“Availability of the IMF loan is critical,” said Ammar Habib Khan, a senior non-resident fellow at the Atlantic Council. But Farooq Tirmizi, the CEO of Elphinstone, a startup geared at Pakistani investors, said that even if the IMF program resumes, it won’t fix all the problems, since the main issues plaguing Pakistan are “not economic, but political, with a government in place that is not willing to make structural changes.” Pakistan’s economic crisis was at the center of a political showdown between Sharif and his predecessor, Imran Khan, last year. Khan was ousted by a no-confidence vote in April after Sharif accused him of economic mismanagement. Vendors sell fruit under lights lit by batteries in Lahore, Pakistan, on Jan. 23. Millions of people across Pakistan were plunged into a blackout prompted by a power grid failure.

The situation has remained turbulent since then. Pakistan has gone through three finance ministers in less than a year. The last two were part of the current government, raising questions about whether Sharif can hold onto power. The country is expected to hold a general election this summer. The tumult comes as Pakistan faces a fresh wave of attacks by militants. Earlier this week, a suicide bomb ripped through a mosque in the city of Peshawar, killing at least 100 people. It was one of the deadliest attacks in the country in years. People are suffering in the meantime. Farmers who lost cotton, date, sugar, and rice crops to flooding still need help. The World Bank predicted in October that as many as nine million Pakistanis could be pushed into poverty without “decisive relief and recovery efforts to help the poor.” High inflation is only boosting pain for households struggling to make ends meet. Food prices in January rose 43% year over year, according to data released this week.

Attention focused recently on a man in the southern province of Sindh who lost his life in a scramble to obtain a bag of subsidized flour handed out by local authorities. He was crushed to death by the crowd alongside him.

CONCLUSION

Pakistan has made PAKISTAN VISION 2025: one nation-vision. If political and economic stability can came out of this catastrophe