“Alas! How sad when reasoners reason wrong.” These words by Sophocles beautifully embody the sadness and the tragedy one experiences reflecting upon Pakistan’s economic condition. A state arduously realized through a paralysis of policymaking, and a comedy of errors – a dark one, indeed. Evident, most recently, by the second highest single-day depreciation of the rupee – amounting to a 9.6 percent loss in value – as the artificial (and more importantly, terribly miscalculated) value cap unraveled after three months of forceful imposition.
Now, as the value of rupee adjusts in accordance with market fundamentals, the dollar-rupee parity will likely settle north of PKR 280 – correcting and over-compensating for the ill-conceived approach of fixing the interbank rate of the dollar – notoriously referred to as the Dar peg. Despite the (always) inevitable reversal, the economic ramifications which are beginning to manifest are going to be catastrophic: unleashing unprecedented inflationary pressures, eroding purchasing power, and ushering a period of stark scarcity of essential commodities.
Ironically, the policy measure to arbitrarily fix the exchange rate, window-dressed as the silver bullet and steered by PML-N’s Ishaq Dar, derailed the country’s gradual course to economic rehabilitation being led, at the time, by one of PML-N’s own: Miftah Ismail. Not only did the Dar peg undo the impact of some tough, yet necessary measures taken by Miftah to alleviate the pressure on the foreign exchequer, such as the unfreezing of energy prices and reversal of the oil subsidy, but also served to halt the incoming tranche of IMF funds. And in doing so, divorced the country from possible avenues of short-term respite, setting it up for failure.
The mechanics behind the Dar peg, from its very enforcement, were in defiance of economic rationale and in oblivion to the country’s fiscal reality, personifying all but the triggers of an economic meltdown. The biggest loss was accrued in the form of depleted foreign reserves as the consequential cost of setting a clearing price through administrative measures. Three months of ensuing disparity and widening spread between the interbank and the real market value against the greenback suppressed exports, as businesses voluntarily delayed incoming payments, disincentivized foreign direct investments as a consequence of overinflated value and discouraged the inflow of remittances through formal channels, owing to an illegal, yet lucrative, alternative - hundi. Thereby, limited fiscal space and ability to finance imports, including those of key raw materials and intermediate goods distorted local supply chains which in turn lead to economic contraction, and fueled the first-order of inflation.
In the absence of additional sources of finance: default on its external debt, implying that the country will no longer be able to import energy and petroleum among other commodities. Due to the ensuing scarcity, prices will increase, the government will ration both fuel and power, which will directly impact the operations of major industries. Supply-chain disruptions will follow, resulting in business closures, low levels of production, and even greater scarcity.
Inadvertently, the combination of these interim outcomes deepened the dent on foreign reserves, further exposing the country’s long-standing, perennial crisis – the balance of payments. In a series of policy misadventures starring both PTI and PML-N, the Dar peg surfaces as the latest episode, but alarmingly may also be the last as the possibility of sovereign default stands inches away from realization.
When PML-N assumed guard, riding on the vote of no confidence against Imran Khan that ousted the PTI in April of 2022, the country – unsurprisingly – was staring down the same, albeit lesser intense, crisis. Among various facets of PTI’s economic mismanagement (detailed here with evidence from before-after economic indicators), Imran Khan’s decision to freeze energy prices and subsidize the oil price hike prior to his departure was arguably the most disastrous – another example of an ill-timed and ill-reasoned policy – akin to that of Ishaq Dar’s, which bled debt-based dollar reserves.
Recipe for default
The country, for a while now, has been in a downward spiral undergoing a balance of payment crisis, explicitly losing out on its foreign exchange reserves, and implicitly, on its ability to sustain a functioning economy – flirting with the ever-increasing likelihood of default. With the scheduled debt repayment of $500 million made to a Chinese commercial bank, Pakistan’s foreign exchange reserves have plunged to $3.7 billion – dangerously aggravating an already complex macro situation and placing the country at the brink of economic collapse.
Let’s unpack the crisis. Pakistan’s dependency on foreign goods - primary, intermediary, tertiary - runs deep. For the fiscal year 2021 – 22, alone, Pakistan’s import bill was $80.1 billion, averaging out to roughly $6.6 billion a month. Now with close to $3.7 billion in reserves, the government barely has enough to cover three weeks 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.
It is imperative to acknowledge that Pakistan’s biggest import is that of oil – the energy source for running not just industry but the country itself. Disturbingly, as per the findings of a report submitted by the Petroleum Division to the Auditor General of Pakistan in December of last year, Pakistan has already consumed 79.8% of its total oil reserves, suggesting the inevitable need to import even more. The gravity of the situation is compounded by factoring in $8 billion worth of debt that Pakistan must repay by March, and $21 billion by end of fiscal year.
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. Upon this trajectory, Pakistan is likely to face shortage of foreign currency within days. And in the absence of additional sources of finance: default on its external debt, implying that the country will no longer be able to import energy and petroleum among other commodities. Due to the ensuing scarcity, prices will increase, the government will ration both fuel and power, which will directly impact the operations of major industries. Supply-chain disruptions will follow, resulting in business closures, low levels of production, and even greater scarcity. Due to lack of readily available food items, prices for even the most basic ones will skyrocket. The effects will cascade through all economic sectors, including health.
A crisis of this nature has the potential to mutate, exponentially, and undo decades of economic growth, development, as well as social cohesion. For a country of over 225 million, where 22% of the population lives under the poverty line, and 17% barely over, the outcomes can be calamitous, especially given the brewing socio-political unrest.
The dance with IMF
Given the corner in which the country has been pushed, courtesy of its decision-making elite, there is no desirable out. Default can never be one. The only path to stabilization, that too, only for the short-term, is through the revival of the IMF program given the scale of Pakistan’s external financing needs.
The IMF is set to field its delegation to Pakistan on January 31st, resuming the 9th quarterly review of a funding program which has been pending for almost four months. While the plan to implement IMF-mandated conditions is materialized, the government should take the opportunity to negotiate an increase in the bailout package, possibly a bigger loan program to execute the much-needed rescheduling, and build a case for IMF-led debt restructuring over the next three to five years. This would buy the government some time, at least, to focus and address its long-term structural deficiencies that have contributed to the balance of payment crisis.
Circling back to current needs, the way the IMF works is by binding policy choices, referred to as structural adjustment programs for recipient countries to employ, in exchange for funds. The IMF proposes austerity measures, which include, but are not limited to, cutting public spending, reversing government subsidies, deregulating key industries, and postulating tax structures. Furthermore, the conditions levied entail the adoption and continuation of a freely floating exchange rate to address problems with fiscal and current account deficits. For Pakistan, the program is not very different.
Contrary to political rhetoric and popular (mis)opinion, the IMF’s objective is not to hijack Pakistan’s political or economic autonomy (or haqeeqi azadi, as more commonly referred to these days), rather provide prescriptions for the country’s deteriorating economic health. As it happens, the serious the ailment, the stronger the prescription. The implementation of the IMF-proposed conditions will therefore not be devoid of financial pain and trauma, felt most acutely by ordinary citizens, especially as the economy readjusts making up for the compound losses accrued post the Dar peg debacle.
As the market settles to a new equilibrium exchange rate and the subsidies are reversed, the price of petroleum will increase, which will spur an increase in the prices of power, followed by an increase in the prices of staple commodities. Overall, the economy will experience a rise in inflation ranging between 30 to 40%, coupled with increase in poverty due to the loss in value of currency and purchasing power – calamitous for the common man, yet an outcome ten times more desirable than what may be or could have been had the country defaulted: outright collapse of social, economic, and political systems.
Realizing long-term success
Depleting foreign reserves, and a BoP crisis only 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.
The IMF can only help with Pakistan’s short-term liquidity woes. It may agree to do so now, it may not again. To steer away from the possibility of default, ever in future, the country needs to rectify its trade deficit, and build on its foreign reserves. Among various other micro and macro-interventions, this can be realized by incentivizing the deployment of capital away from an unproductive real estate sector, for instance, and more towards capital formation that enables industrial growth, and creating a business enabling environment that supports export-sectors and facilitates business-led growth. Economic policy ought to focus on building the capacity of local firms to better integrate with global value chains and produce high value-added goods, along with reevaluating and reformulating competition policy and laws, as well the country’s investment policy and promotion protocols. This must be accompanied by a serious attempt at designing and implementing a robust energy policy that alleviates the country’s dependency on imported sources of energy.
However, at the heart of all such reforms lay political intent and will. “Alas! How sad when reasoners reason wrong.”
(The research carried out by the author, and the opinion expressed is solely his own. It does not reflect the viewpoint or findings of his organization)