(NOTE: This is a reprint of a story that was published in the India Today edition dated March 27, 2023)
We have never defaulted in the past and we won't default now," asserted Pakistan's federal minister for finance Ishaq Dar on March 3, looking irritated at the persistent questions journalists were lobbing at him at a press conference. His irritation stemmed from ongoing speculation about the country's crisis-wracked economy; the latest blow dealt by credit ratings agency Moody's, which had downgraded Pakistan's sovereign rating to Caa3, signifying "increasingly fragile liquidity and external position" and a raised risk of default.
Dar painted an optimistic picture at the press conference, trying to assure those assembled that a long-pending stafflevel agreement with the International Monetary Fund (IMF) was just round the corner, that bilateral funds would soon be flowing in to shore up the dangerously low foreign exchange reserves and that he had everything under control. Not many were convinced with his bluster. Since he took over the reins of the finance ministry in September-elbowing out fellow Pakistan Muslim League-Nawaz member, the Whartoneducated Miftah Ismail-Dar has seemed like a bull in a china shop. None of his boastful claims before he came into office-that he would control inflation, renegotiate stringent IMF conditionalities and bring the plunging rupee back under Rs 200 to the US dollar-have materialised.
If anything, Dar's blundering attempts to pull back processes put in place by Ismail have led to a faltering economy going from bad to worse. Inflation is at a historic high, with food inflation clocking in at over 42 per cent and transport inflation at over 39 per cent; an IMF tranche that was due last November is still in limbo while the government has been forced to accept all harsh conditions. The rupee at one point plunged to almost Rs 300 to the dollar before making a modest recovery.
As exports decline and debt repayments become due, Pakistan's forex reserves stand at just over $3.8 billion-sufficient for a month of imports-and making the threat of potential default very real. Moody's estimates Pakistan's external financing needs for the remainder of fiscal year 2023 (ending in June) at $11 billion and that of fiscal 2024 at around $35-36 billion. In addition, the agency estimates Pakistan's current account deficit at around $10 billion. The State Bank of Pakistan recently raised interest rates by an unprecedented 300 basis points to 20 per cent, which will likely crush the formal sector of the economy and make it non-competitive. Fuel prices have been raised so high that there is a real danger of social unrest. On February 16, the price of diesel was hiked by Rs 17 to cost Rs 280 a litre, while petrol prices were increased to Rs 272 a litre, a hike of Rs 22. One meme likened Dar to the electrician who came to change a light-bulb but ended up burning down the wiring of the entire house.
Of course, it's not all Dar's fault. The real problem with Pakistan's economy is structural and has been brewing for decades. "Basically, we've been living beyond our means and consuming more dollars than we have been earning for a long time," says economist Asad Sayeed. "Now, the difference is, we are faced with a difficult external environment, with the rest of the world unwilling to bail us out again." The difficult environment, says Sayeed, includes "a changed geopolitical situation" in which Pakistan cannot extract the "geopolitical rent" it could previously from agencies like the IMF and bilateral donors, "donor fatigue" after the pandemic, the Ukraine war and a "commodity supercycle"-a period of high growth in demand-that is leading to a lot of imported inflation.
But longstanding domestic issues, such as the inability to tax big agriculturists, property owners and traders, raise the tax to GDP ratio (tax revenue for a country measured in terms of GDP), while high government borrowing, large current account deficits (it was as high as $2.5 billion in January 2022, but fell to $0.2 billion in January 2023 after stringent import restrictions), the inability to increase exports and economic mismanagement have played their part.
The widespread consensus is that, for decades, we have had no real structural reform that would have made Pakistan competitive in a globalised world," says business journalist Khurram Husain. "This current crisis is nothing new, economically or politically. The economic crises in 1999, when Pakistan was sanctioned after exploding the nuclear devices, or the one in 2007, with terrorists running amok across the country, were probably worse. But this one feels more serious because there doesn't seem to be a roadmap to get out of it."
Former prime minister Imran Khan is gunning for new elections, arguing that it's the only way out, but it's not clear that polls would offer any solution to the economic crisis-political instability could make things worse. And any new government that comes in will also find itself in the same quagmire at best.
The current crisis was specifically triggered by Pakistan's economic managers playing fast and loose with the IMF and reneging on promises they had agreed to implement. Initially, it was the Imran Khan that went against the agreed Fund programme and froze fuel prices in February 2022 in a bid to shore up popular support while it faced the threat of being ousted. That immediately led to a suspension of the muchneeded IMF funds.
However, when Khan was ousted from power last April through a vote of no-confidence, the new government of Prime Minister Shehbaz Sharif also temporised for over a month on putting the programme back on track by bringing fuel prices in line with international rates. That further dented trust with the IMF. Eventually, new promises were made by then finance minister Ismail, but he was soon replaced by Dar, who promptly broke promises of not intervening in the currency markets in an attempt to shore up the value of the rupee, and not providing unfunded energy subsidies to businesses.
The cumulative effect of this reneging on an agreed 'reform' programme has been that the IMF has delayed its support. Adding misery to Pakistan's position is that bilateral donors, who often helped out the country in previous crises-China, Saudi Arabia, UAE among them-have made the resumption of the IMF programme a prerequisite for any further support. While China has sent a deposit of $700 million in February as part of a refinancing of $3.3 billion of debt that was to be due soon, the Sharif government has discovered that its oft-touted 'close ties' with Arab countries could not convince the latter to jump in with yet another bailout. WIDESPREAD SOCIAL DISCONTENT
Meanwhile, as the country's fiscal situation becomes precarious, the real impact is being felt on the ground. Fuel price and transport cost increases, energy price hikes mandated by IMF conditionalities, a nearly 50 per cent devaluation of the rupee year-on-year and international inflation have served as the main drivers of skyrocketing domestic inflation that has the poor and the middle class crying out in anguish.
Even the IMF admits that the risk of "widespread social discontent and political instability" as a result of the fiscal belt-tightening is "high". "Social unrest fuelled by increasing prices and shortages of essentials, rising inequality, inadequate healthcare, financial and social scars from the prolonged pandemic, and heavier household debt burdens," it assesses, could "trigger political instability, capital outflows, higher unemployment and slower economic growth".
Unfortunately, aside from advocating more targeted social subsidies, the agency doesn't really have a solution to avert this risk. "At the end of the day, all IMF programmes are about austerity and slowing growth," says Husain. "This was inevitable. And at the moment, the Shehbaz Sharif government is simply trying to manage things, rather than solve the crisis." Then there is the lingering effect of the devastating floods that hit Pakistan in 2022, which caused endless misery as well as economic losses to the tune of billions of dollars.
In the meantime, the country's business representatives are also screaming blue murder. The soaring input costs, the lack of availability of foreign exchange for imports and the unprecedented interest rate hikes, they fear, will make them completely uncompetitive and make breaking free from this depression cycle unviable. "But no one in government is thinking that far ahead right now," says Husain.
But can Pakistan go the way of Sri Lanka? That is, could it default and go bankrupt? Most analysts, including Moody's, seem to feel that the possibility may be averted. "Could it default? Yes," says Husain. "Will it? It's unlikely."
That may be all that Dar too is hoping for as well. He is counting on the fact that the harsh economic actions taken in the past couple of weeks will be enough for the IMF to conclude its long-pending review and release the next tranche of funds. That, in turn, will unlock further multilateral and bilateral donor funds for propping up the economy as well.
"Had the government taken these actions earlier, as agreed with the IMF, we wouldn't have been in such a crisis," says Sayeed. "The worst of the inflationary effects would have been over and all these crises would not have come at the same time. But now we simply don't have any degree of freedom. Long-term adjustments will have to be made," he adds. "And it's not going to be smooth-it's going to be rough sailing."
The events in Pakistan are being keenly watched across the globe. While efforts are on to pull the nation back from the brink economically, the continuing volatility in Pakistan's domestic politics keeps threatening its revival.
Subscribe to India Today Magazine
