Pakistan is rushing to take urgent action to address the country’s severe financial problems. But what are the elements driving the nation toward an inevitable economic crisis? Here is everything you ought to know.
With extremely high inflation, dangerously low foreign exchange reserves, and international lenders like the International Monetary Fund (IMF) unwilling to provide more funding, Pakistan’s economy is in severe circumstances. Even though the economy has been struggling for a while, the floods of 2022 inflicted tremendous devastation on the nation, destroying vital infrastructure and uprooting millions of people.
Pakistan’s economy is currently at a point of collapse, and it is counting on the IMF to make changes to the Extended Fund Facility (EFF) that was formed in 2019, as well as assistance from friendly nations in the form of long-term loans or gifts.
The issue is so severe that the government recently put up a building that had served as the Pakistani embassy in the US for auction. Even more extreme steps are being taken by the government, such as forcing markets, restaurants, wedding venues, and shopping malls to close early in the hopes of saving the country 62 billion Pakistani rupees, or about $273 million, on energy imports.
All national government agencies have been instructed, among other things, to limit their use of power by 30%. The economy of cash-strapped Pakistan has been continually in bad health for the past few years, but in 2022, things worsened.
The root causes of the crisis
- Pakistan’s present economic crisis is mostly due to a short-sighted policy choice that resulted in excessive expenditure on non-developmental and economically unviable projects. Economic mismanagement and the funding of fruitless infrastructure projects like the Gwader-Kashgar Railway line project through long-term loan instruments, as well as a heavy reliance on foreign borrowing rather than domestic institutions, increased the country’s problems. The construction of the China-Pakistan Economic Corridor (CPEC) raised the debt burden, allowing for ever-increasing foreign debts. Furthermore, CPEC incurred a Chinese debt of US$ 64 billion against Pakistan, initially assessed at US$47 billion in 2014.
- Pakistan’s foreign exchange reserves have plummeted due to a rising trade imbalance and declining investment. Foreign currency reserves declined 1.97 per cent to US$23.550 billion in the second week of November 2021, from US$24.025 billion the previous week. Commercial bank reserves have also fallen to US$6.605 billion from US$6.699 billion in November 2021. The value of the current reserves has decreased due to the devaluation of the Pakistani rupee against the US dollar.
- The ongoing depreciation of the Pakistani rupee versus the US dollar has added to the country’s mounting external debt. Falling confidence, a low rating from international rating agencies, and Pakistan’s greylisting in the Financial Action Task Force (FATF) have kept foreign investors away. According to figures from the State Bank of Pakistan, FDI inflows into Pakistan have never exceeded 1% of GDP in the last ten years. The relentless cycle of obtaining fresh loans and repaying old ones have pushed Pakistan into the renowned ‘debt trap’. Furthermore, due to the international community’s unwillingness to give loans to Pakistan, the government was obliged to rely mainly on China and Saudi Arabia, rendering it subject to their complicated conditions.
- In Pakistan, inflation reached its peak in November 2021. This is mostly due to the global surge in crude oil prices, which has resulted in higher freight rates. Significantly, Pakistan is a net importer of staple foods such as lentils, wheat, edible oil, and sugar. Notably, food imports account for around 16% of Pakistan’s total imports. The global surge in food costs has had an impact on Pakistan. Food prices are also blamed on a poor harvest in the previous planting season. The recent sharp increase in energy costs has caused enormous inflationary pressure and burdened the average person with additional spending.
- Pakistan has been dealing with a growing trade deficit caused by rising import costs and shrinking exports. In the fiscal year 2018, Pakistan’s trade imbalance reached an all-time high of US$37.7 billion. The trade imbalance increased by more than 117.25 per cent in the first five months of the 2021-2022 fiscal year. Asian Development Bank said in February 2022 that Pakistan had one of the world’s lowest trade-to-GDP ratios. The onset of the Covid-19 epidemic aggravated the issue. During the epidemic, major exporting commodities such as cement, textiles, leather, and sporting goods had no buyers. The composition of Pakistan’s trade basket, which imports necessary products and exports non-essential items, has significantly influenced the trade deficit. Pakistan primarily imports goods for domestic consumption.
How can Pakistan’s economy be reformed?
Pakistan wishes to pursue fundamental changes, such as tariff liberalization or replacing state ownership with private ownership. In recent years, the government has undertaken some substantial adjustments.
1. Current action
One such example is the independence of the State Bank of Pakistan (SBP). The formation of monetary policy has given the central bank autonomy, and it is now fully responsible for preserving price stability.
Hundreds of industrial imports had their taxes decreased as well, but the installation of additional customs and regulatory duties, unfortunately, cancelled these reductions. Although there were no fundamental changes to how taxes were managed, technology was employed to assist taxpayers.
Despite their noble intentions, these improvements have had minimal influence on Pakistan’s economy. Because other policies, such as concessionary lending, have an expansionary impact, SBP autonomy does not contribute to price stability. Trade and production limitations and record-high global commodity prices are also diluting the influence of monetary policy.
2. Skill Development
Because neither the public nor private sectors produce enough graduates with the requisite abilities, information technology is an excellent example of an underpowered sector. Instead of offering tax breaks or credits to the IT industry, Pakistan can achieve better outcomes by investing in IT-related skills that the private sector needs. Better-trained IT workers may benefit any organization, whether or not it is situated in Pakistan.
3. Industrial Development
Concentrating industries in strategic places is a fundamental component of economic corridors. To thrive, the sector needs more than simply proximity to highways or trains; it also requires a climate that supports investment and skilled labor.
The government may employ tax cuts or other incentives to encourage such growth. And it is critical that whatever is built within an economic corridor spreads outside of it, connecting the nation’s exports to the global supply chain in Pakistan and throughout the world.
The global economic crisis is hurting several countries. Even though the crisis was between Russia and Ukraine, Pakistan is one of the countries experiencing the impact. The economic crisis in Pakistan is severe. The country’s foreign exchange reserve has been declining in recent years.
Sri Lanka’s economic crisis recently grabbed headlines, and if Pakistan wants to avoid a similar problem, strict economic management measures must be applied.
The external environment has deteriorated due to the pandemic and the war. The Chinese economy, which has been a significant backer of these suffering South Asian economies, has faced financial difficulties due to the pandemic and lockdown. The IMF funding is subject to criteria that, given the political limitations, require greater effort to satisfy.