What brought Pakistan’s economy to the verge of collapse, and why does it matter to India?

What brought Pakistan’s economy to the verge of collapse, and why does it matter to India?

According to the World Bank, the “weakest economy” in south Asia is Pakistan, which has been struggling with soaring inflation for the previous few quarters. According to government figures released on January 28, the declining foreign exchange reserves have plummeted to an all-time low of $3.1 billion, compounding the nation’s problems.

Islamabad woke up to blaring alarm bells as the foreign exchange reserves could barely withstand imports for two to three weeks. On the other hand, according to December 2022, inflation has doubled year over year to reach 24.5 per cent. With a 35 per cent increase in inflation, food costs have risen the greatest.

The State Bank of Pakistan (SBP), the nation’s central bank, brought up the crucial borrowing costs by 100 basis points on January 23. This brought it to 17 per cent, which is the highest it has been in 24 years. Consequently, the unofficial cap on the US dollar/Pakistani currency (PKR/USD) exchange rate was removed as part of the criteria set forth by the IMF for offering support. This led to the local currency’s value vs the dollar hitting a 20-year lowest of Rs 262 on January 27.

For Pakistan to avert a total economic collapse, the IMF’s $1.1 billion assistance—part of the $6 billion rescue plan announced last year—will be essential. On January 27, the fund announced that a delegation would be travelling there the next week to meet with the administration.

Mismanagement

According to experts, Pakistan’s fiscal health has been impacted by managing a political economy that depends on assistance and grants from critical allies and multilateral organisations. Governments in the past have come under fire for not doing enough to increase the number of taxing jurisdictions and the size of the tax base.

Additionally, Pakistan’s economy was ultimately harmed by its steeply subsidised energy costs and one of the lowest retail prices for gasoline and fuel in South Asia. According to data from the last two decades, the budget deficit reached an all-time high of $25.31 billion in 2019 from a low of $2.25 billion in 2004.

“While we could not boost income and extend the tax base, expenses continued to rise. The fiscal deficit continued to grow as a result. Instead of funding infrastructure development, the money raised is primarily used for opex (operating expenses), such as paying salaries and carrying out other governmental obligations “Ammar Habib Khan, Chief Risk Officer at Karandaaz Pakistan, a non-profit organisation that supports SMEs’ access to financing, made this statement while speaking with Moneycontrol.

As a result of the growing fiscal deficit, Pakistan’s reliance on loans from China and friendly Gulf nations like Saudi Arabia and the United Arab Emirates to maintain its economy increased. The IMF postponed the delivery of $1.1 billion to Pakistan, scheduled for disbursement in November, primarily due to Pakistan’s lack of fiscal responsibility. The international financial organisation has instructed Islamabad to enact austerity measures, starting with increasing energy prices, tax rates, and effective loan rates.

The IMF’s continued help must be obtained through “tough and unpleasant measures,” according to Prime Minister Shehbaz Sharif. According to SBP, the nation will require $20 billion to pay off debt obligations in the upcoming year.

Similar to the crisis in Sri Lanka?

Sri Lanka’s economy completely collapsed in the middle of 2022, and the nation ran out of foreign reserves. Imports ceased as a result, depriving the inhabitants of necessities. The nation’s president, Gotabaya Rajapaksa, was compelled to quit and flee due to the widespread unrest that ensued.

Do we currently see a comparable crisis in Pakistan? Despite certain parallels, experts contend Islamabad is better suited to prevent a sovereign default. After the foreign reserves had fallen as low as $1.8 billion in April 2022, the Lankan government contacted the IMF. On the other hand, Islamabad has been communicating with the fund since 2019 and successfully obtained a $6 billion bailout last year.

“Some bilateral loans from friendly nations like Saudi Arabia, the United Arab Emirates, and China will come due soon, but they will be rolled over. Multilateral loans would likewise be renewed similarly. Only when paying private debt is a necessity does the restructuring become necessary. So we won’t experience a crisis as Sri Lanka did, “the economist stationed in Islamabad asserted.

“There is no crisis resembling that of Sri Lanka in Pakistan. Even yet, people have started comparing, even if it was never looked at. In Sri Lanka‘s situation, private creditors or private bondholders were responsible for almost 50% of the country’s external debt. Only 8% of the debt owed by Pakistan is to private creditors or bondholders. Pakistan’s subsequent private loan payment is due in April 2024, “said Ammar Khan.

Because the IMF took longer than expected to disburse the $1.1 billion tranche because it was dissatisfied with the fiscal tightening measures taken by the Pakistani government, the crisis is claimed to have worsened during the past few weeks. Analysts pointed out that the IMF is likely to be pleased with the government’s efforts and increase its engagement now that the cap on energy prices and currency rates has been removed and lending rates have been raised.

The Express Tribune claimed that the IMF’s approval of Islamabad’s fiscal conservatism measures would open the door for more significant bilateral aid. This includes the $3 billion loans announced by the UAE and Saudi Arabia. A third of Pakistan’s entire foreign debt, or $30 billion, is owed to China, its closest ally in the area and largest lender. In light of the situation, analysts added, the nation is predicted to refinance the majority of its debt.

“China and Saudi Arabia, two vital allies of Pakistan, prevented a Sri Lanka-like crisis from developing in this country. Sri Lanka was unable to import anything, while Pakistan was able to, “said Raja Gopal Chakraborti, professor at Calcutta University’s department of South and Southeast Asian studies.

Why does it matter to India?

India has not yet responded to the economic crisis in Pakistan. On January 28, when asked about India’s position on recent events in Pakistan, S Jaishankar, the country’s foreign minister, indicated that it would not be appropriate for him to comment.

Shehbaz Sharif had made an economic outreach to India a week before, claiming that the seven decades of strife between the two nations had only brought about economic misery. The softer stance Islamabad takes, which has made Kashmir the focal point of future negotiations with India, is viewed through the lens of its economic difficulties.

India will undoubtedly respond to a humanitarian appeal for food and medicine. Still, Chakraborti noted that if Pakistan’s economy is unstable, it will have less money to fund proxy conflicts with India. However, some Indian analysts are highly concerned about Pakistan’s deteriorating economy and believe it could have strategic and security ramifications.

“In the event of a complete economic collapse in Pakistan, India may face an influx of refugees. furthermore, if Pakistan were to fall apart, terrorist organisations within that country could be able to strengthen their positions, which would be detrimental to India’s interests “Sourish Ghosh, an independent researcher, stated this to Moneycontrol.

“SAARC will lose its significance because Pakistan and Sri Lanka are both experiencing economic crises, and if China bails out Pakistan, China will take control of the show,” Ghosh continued.

Pakistan has a long way to go.

Increasing business confidence is one of Pakistan’s top priorities for recovering from its economic distress, according to Nakhoda, who is also an assistant professor of economics at the Institute of Business Administration in Karachi (IBA).

“Pakistan relies on foreign aid, but the country risks having to take even more bureaucratic steps to restrict the flow of funds if it waits. Company trust is eroded by actions such as LC (letters of credit) opening limitations and reduced business hours. As time goes on, the corporate landscape will inevitably evolve ” He made a proclamation.

Experts also agree that Pakistan needs to implement a two-pronged strategy, concentrating on both medium- to long-term goals for economic restructuring and short-term targets for lowering external debt.

Analysts point out that reducing dependence on oil by creating a robust public transport infrastructure, deregulating fuel costs, and promoting the expansion of export-oriented companies can improve Pakistan’s financial status. However, whether Islamabad has the political will to carry out significant reforms is still being determined.

Edited by Prakriti Arora