The transfer of political power in Pakistan has barely ever been smooth. Incoming governments have not only not only had to endure periods of civil and political turbulence, but in most, if not all, instances have had to inherit a tumultuous economy. Likewise, when Imran Khan assumed charge of Pakistan in August 2018, when the country’s external debt was reeling at $93 billion – an increase of over 50% from 2013 (when PML-N came to power). The economic policies pursued by the PML-N government had left Pakistan in a balance of payment (BoP) crisis, a record high debt, and a currency which at the time was at one of its highest levels of devaluation. The economic scenario posed increased risks to Pakistan’s medium-term capacity to repay – all but signaling towards an impending crisis.
Three and a half years later, the country finds itself amidst the same crisis, only, it happens to be much amplified. Pakistan’s external debt has grown to almost $130 billion (approximately 45% of the overall GDP); and trade deficit has increased to $35.4 billion (i.e., 170% of what it was, same time, last year). The country barely has enough reserves ($11 billion) to cover two months of an ever-increasing import bill – implying the lack of financial capacity to pay for essential imports (with wheat being one of them based on recent import patterns). This is likely to spur a rapid decline in the value of Pakistan’s currency and can possibly push the country into (hyper)inflation; unless the government is able to leverage additional sources of financing.
A crisis of this nature has the potential to mutate, exponentially, and undo decades of economic growth and development. Quite recently Lebanon descended into one of the biggest economic crises witnessed, globally: triggered by the depletion of its foreign reserves which in turn deepened the negative asset position of the central bank; Lebanon’s currency lost 90% of its value from 2019; GDP per capita fell by almost 40%; inflation soared to almost 150%; and poverty levels skyrocketed to surpass 80%. In simplistic terms, Lebanon’s economic system disintegrated to the level where even a staple commodity as basic as flour became a challenge to acquire. While Pakistan may not be in a situation as calamitous, further mismanagement can propel the country in a downward spiral – within weeks. The outcome can be catastrophic, especially given the brewing socio-political unrest.
Depleting foreign reserves, and a BoP crisis may act as triggers, but it takes decades for an economy to become this vulnerable, owing to inept governance, structural deficiencies, below-par investment climate, elite capture, rent-seeking, and fiscal mismanagement, among other contributing factors – all of which have been conspicuously at play in Pakistan. Exogenous shocks, over the last two years have only further contributed to the dishevel. Supply chain disruptions induced by the pandemic, coupled with an increase in global energy prices have led to double-digit inflation and sustained periods of economic contraction.
Imran Khan’s recent decision to freeze energy prices, subsidizing the oil price hike, despite increasing international prices was arguably the most disastrous intervention
Mismanagement under PTI rule
Considering Pakistan’s checkered (economic) history and foundational weaknesses, laying the blame squarely on Imran Khan and his government would be unfair, yet absolving the outgoing Prime Minster and his government of sheer economic mismanagement, would be no less of a sin. Given the country’s economic health at the time (2018), it was obvious that economic revival would be an uphill battle – a reality that IK-led government claimed to be conscious of. Yet, as though it seems, failed to comprehend, and conceive the depth of macro challenges the country was facing, apparent from the newly formed government’s indeterminate and indecisive approach on addressing the most pressing and urgent call at the time (the IMF’s bailout package).
Despite borrowing from bilateral partners (China, Saudi Arabia, and the UAE) – and the accumulation of greater debt in the process – the government was unable to find its footing out of the predicament, and eventually, and as expected, had to go to the IMF agreeing to a tailored structural adjustment program, only a year too late. Momentarily, the government was able to avert the BoP crisis, but beyond austerity measures and new bailout packages there was little indication of a long-term strategy to address the country’s macroeconomic woes, or at the bare-minimum ensure freedom from debt entrapment.
Currency devaluation
One policy avenue to correct the BoP imbalance entails exchange rate adjustment – when left to float freely in the market it tends to change in the direction that restores balance. Opposite to PML-N’s questionable approach, leveraging the increase in foreign reserves, to artificially peg and overvalue the rupee (during its previous tenure from 2013 – 2018), the PTI government made the tough – yet economically sound – decision to adopt freely floating exchange rate mechanisms.
The currency depreciated as a correction to its past overvaluation – making imports expensive and conversely exports cheaper. In theory this would help improve the current account deficit. However, it is important to realize that an exchange rate adjustment, alone, does not warrant the desired outcome unless it is bundled with reforms enhancing the country’s investment climate, building competitiveness across sectors, and increasing domestic productivity – all of which together propel the transformation from an import- towards an export-oriented economy.
On the contrary, during PTI’s tenure the persistent structure of the economy was such that it incentivized the deployment of capital in an unproductive real estate sector, for instance, rather than productive capital formation that enables industrial growth (due to the structural imbalance between the two in terms of taxation, i.e., 5% on real estate versus 29% on industrial). Majority investments were thus parked in non-productive, non-tradable sectors – part of the economy which can neither be substituted for imports, nor produce goods that can be exported. Economic policies were characterized by the allowance of broad-based subsidies and extension of amnesty schemes – rendering the economy as well as exporting sectors hugely uncompetitive.
The only time Pakistan has had to consistently import wheat post-2010 has been during PTI’s three-year rule
Furthermore, the country experienced failures in domestic management as evident from the inability to develop integrated supply chains, or backward integration to ensure food security. This resulted in domestic food supply shortages and an increasing need to (even) import staples such as wheat, pulses, and edible oil. (Putting things into perspective, the only time Pakistan has had to consistently import wheat post-2010 has been during PTI’s three-year rule).
PTI’s legacy - worsened economic indicators
A snapshot of key indicators, before and after PTI’s rule, unsurprisingly, highlight worsening of economic conditions across most fronts. When PTI took charge, the accumulated stock of circular debt – a public debt which is a cascade of unpaid government subsidies – stood at Rs. 1.14 trillion ($6 billion). Over the last three and half years it has more than doubled to Rs. 2.5 trillion ($14 billion). Not a single noteworthy measure was employed to reform power distribution companies (DISCOS), despite their role in the accumulation of circular debt.
Similarly, the PTI-led government has added over Rs. 18 trillion to public debt (an average increase on Rs. 14.2 billion/day versus PML-N’s average increase of Rs. 5.6 billion/day), which is more than the liabilities accumulated by any single government in the country’s history. This showcases an unstainable increase of 20.3% per year, raising public debt to Rs. 42.8 trillion, or 83.5% of the country’s GDP. As a metric of performance, former Prime Minister Imran Khan himself had claimed that his government’s failure (or otherwise success) to deliver should be gauged by its inability (or otherwise ability) to bring the total amount of public debt down to Rs. 20 trillion. On this end, the government seems to have failed by quite a margin.
High fiscal deficit
Fiscal deficit – reflective of the shortfall in government’s income in comparison to its spending – has soared to a record high of Rs. 4.6 trillion, or 8% of the GDP, highlighting PTI government’s inability to generate adequate revenue while simultaneously failing to control high levels of non-development expenditures. (For reference, Pakistan’s fiscal deficit for the year 2018 was 6.5% of the GDP).
Trade deficit has peaked to $35.4 billion (i.e., 170% of what it was, same time, last year). This is higher than the annual target of $28.4 billion that was set forth by the PTI government – the breach imposing an even heavier toll on foreign exchange reserves which have been sliding downwards. The month of March, alone, witnessed the erosion of foreign reserves from $16 billion to $11 billion on account of a 47% increase in import bill, and debt repayments. The outgoing government’s colossal failure can very well be projected by its inability to pursue fiscal consolidation.
Let’s break this down: $11 billion worth of foreign reserves mean that Pakistan has an import cover that would barely last the country two months. Given the current equation, i.e., the amount of capital needed to service debt and pay for imports, the country has little choice than to tap in its foreign reserves (rather than ideally replenishing them). Upon this trajectory, Pakistan is likely to face shortage of foreign currency (in worst case scenario: default on its external debt) suggesting that the country will no longer be able to import energy and petroleum (among other commodities).
The country barely has enough reserves ($11 billion) to cover two months of an ever-increasing import bill. This is likely to spur a rapid decline in the value of Pakistan’s currency and (hyper)inflation; unless additional sources of financing are leveraged.
Populism, no substitute for sound policy
Considering the gravity of the situation, Imran Khan’s recent most decision to freeze energy prices, subsidizing the oil price hike, despite increasing international prices is arguably the most disastrous intervention and has left majority economists mystified – a textbook example of ill-timed and ill-advised policy that tends to trigger an economic collapse. The petroleum subsidy signifies foregone revenue and levies a cost of Rs. 100 billion per month, leading to a higher import bill, and an insurmountable pressure on the country’s depleting foreign reserves – worsening the country’s fiscal position and only accelerating the BoP crisis.
The decision comes across as a strictly populist one made to pacify inflation-stricken voters, in defiance to the proposal put forth by the Oil and Gas Regulatory Authority (OGRA). While this may offer the semblance of temporary respite, it is a matter of weeks when this policy will push the country spiraling down into an economic abyss – as the subsidy bleeds out debt-based dollar reserves. On the other hand, if the subsidy is reversed to match international market prices, which in the interest of the country and its people the incoming government should, then the price of petroleum will undergo a sudden hike estimated to range between 35% to 50% (depending on how swiftly the reversal is enacted). The ripple effect may in all likelihood cause USD/Rupee parity to touch Rs. 200 to a dollar, and inflation to soar up to 20%.
Soaring Inflation
During Imran Khan’s tenure, Pakistan grappled with high levels of inflation, touching 13%, but in all fairness, PTI’s role and defenselessness could have been discounted for in view of the economic ramifications of the Covid-19 pandemic which activated unprecedented inflationary phenomenon across the globe. However, to exonerate the PTI government for the inflationary summer that awaits would only reflect oblivion to facts and figures.
PML-N’s previous tenure was ridden with inefficient policies, which distorted markets, and set in motion Pakistan’s ongoing affair with external debt. Thus, when PTI came to power the realistic expectation was not of immediate economic reversal, but that of halting further deterioration, and setting the long-term course of economic revival. However, the PTI-government, too, accumulated high amounts of external and public debt; struggled with limiting fiscal and trade deficits; and failed to address structural bottlenecks that impede productivity and inhibit export competitiveness.
Now as PTI relinquishes its control, and PML-N takes over the country finds itself in an even deeper crisis, heading into one of the two directions. Worst case: the country defaults on external obligation, experiences economic meltdown undergoing acute shortage of food, power, medical supplies, and threatening social unrest (similar to the likes of Lebanon and Sri Lanka). Best case: higher level of inflation, coupled with increase in poverty due to the loss in value of currency and purchasing power.
To be continued…
Nauraiz is an Economist who works with World Bank’s Trade, Investment and Competitiveness unit; he tweets @nauraizrana.
(The research carried out by the author, and the opinion expressed is solely his own. It does not in any way reflect the viewpoint or findings of his organization)