There is no more sauce train for Pakistan. Saudi Arabia, Emiratis, Americans and Europeans no longer offer free meals. The Chinese never did anyway, and only the Pakistanis didn’t know about it. Pakistan’s economy will likely become similar to Sri Lanka’s, but much worse. The country is in danger of default. The government has no choice but to face reality.
Former Finance Minister Ishaq Dar, a chartered accountant who claims to be a Nobel Prize-winning economist, added to the confusion by saying Pakistan did not have to accept IMF funding. He said Pakistan should be listened to and its position taken by the IMF. But others have suggested that Pakistan could negotiate its way out of the crisis. However, this plan was also shattered.
Pakistan should pay its bills and stop living and wasting other people’s money. The alternative is either to reform (which means greater poverty in the short and medium term) or to ruin (to default and suffer the terrible consequences). A third option will be tempting; a Pakistan that has tried many times: to take painful steps to overcome the immediate crisis and hope that all will be well in the long run. It is only a palliative, which would only postpone the problem and make the next crisis even more serious and difficult.
The IMF’s wake-up call
Pakistan was running out of options after its foreign exchange reserves fell to just over a month of imports. Pakistan has borrowed all of its foreign exchange reserves of around $10 billion. The Saudis wouldn’t bail them out until they were in an IMF program. A similar situation exists in the UAE. The Chinese were also annoyed by their “iron brother” who failed to make due payments on the CPEC projects.
Pakistan seemed unable to open its purse strings to offer another bailout. However, the Americans were willing to help and were not offered financial assistance. The Pakistanis were not going to block any IMF program, but they were also unwilling to rely on the IMF to help.
An economic collapse was inevitable without an IMF program as soon as the day broke. Last year, Saudi Arabia lent $3 billion to Pakistan. The rest of the reserves would be virtually wiped out in June and July. Pakistan will have to default on its monthly import bill to stay in business. It was already very tense on the stock markets, prices were falling and the rupees were collapsing.
A few weeks ago, it fell from 181 to 202 against the US dollar. Pakistan is unusually harsh in demanding that it stick to its assurances and take the actions it promised, suggesting the rupiah could break through 220-225 if it fails to meet actions prerequisites requested by the IMF.
Pakistan needs deep economic surgery
However, restoring IMF financing will only buy Pakistan time and avert the immediate crisis, without solving the deep structural problems that have plagued the Pakistani economy and made it unsustainable. Recent research indicates that Pakistan is one of the few countries where if its growth rate exceeds 3% per year, the country will face serious balance of payments problems. The balance of payments tends to be easier to manage in most other higher-growth countries.
Another complication is the fact that consumption drives the entire economy. Consumption drives Pakistan’s 6% GDP Rate of growth. A meager 15% is invested; a staggering 12 percent is recorded. Almost every five years, the economy doubles its debt. As a result, the debt becomes unsustainable since growth is anemic. Nearly 80% of federal government revenue was spent on servicing the debt in 2019-20. It is now widely accepted that servicing the debt will take up almost all of the federal government’s revenue in the next budget.
Defense expenditures, pensions, government operations, grants and development costs will all be financed by borrowing. Pakistan does not have the resources because its tax to GDP ratio is only 9%. Additionally, the sector is becoming less competitive due to the high cost of borrowing – the interbank rate is already around 13.75%, which means banks lend at around 15-16%. Due to high electricity tariffs and high fuel prices, the industry’s competitiveness is further compromised.
A basic electricity tariff of around 24 rupees per unit is expected. A peak tariff of around 30 rupees per unit of electricity is also possible. With the end of fuel subsidies, fuel prices will rise another 20% on top of last week’s rise. Inflation will rise even more since it is already around 14%. With the removal of subsidies on fuel and other goods, food inflation is around 25%.
Pakistan needs to undertake deep economic surgery to sustainably restore the economy. It will have to go beyond the simple complex adjustment process. This is one of the most difficult and complicated tasks a government can undertake in an uncertain political climate. Opposition figures such as Imran Khan complicate the life of government and weaponize economic reforms for political gain; on the other hand, the military establishment cannot solve financial problems while refusing to give civilian rulers a free hand.
In addition to political economy, the economic system must be overhauled. Commerce and industry enjoy concessions, tax breaks, hidden subsidies, patronage and so on, in the form of privileges. According to some estimates, around 1.3 trillion rupees are spent there every year. If they were removed, the industry would be thrown into the depths, and there would be massive disruption and dislocation.
A political or military regime cannot deal quickly with the economic and political fallout of this. The predicament Pakistan finds itself in is a kind of existential crisis and cannot provide any simple solution. If reform is not undertaken, inflation, unemployment and unrest will occur; the default will have the same effects and worse. Another year or two of tinkering will lead to an even worse crisis. The future is very turbulent for Pakistan.