Analysing Pakistan's economy - an update

An update on why Pakistani economy is struggling

Analysing Pakistan's economy - an update

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Read more on - Polity | Economy | Schemes | S&T | Environment

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• The story: Many critics of Prime Minister Imran Khan of Pakistan, observing the suffering economy of that nation, have questioned if this was the “Naya Pakistan” he had promised. Though Pakistan’s GDP growth was projected to touch a 4-year high of 5% in the fiscal year ending June 2022, high inflationary risks and a rising balance-of-payments crisis has it on the brink. It is now dependent on external debt bailouts in order to stay afloat.
• The many crises of Pakistan: Pakistan has run into many macroeconomic crises over the past few years - high inflation, current account and trade deficits, lowering foreign reserves, and currency devaluations. It is faced with a combination of these problems again now, leading many to question the leadership.

1. The two present threats to the $263-billion economy are (i) the build-up of inflationary pressures, and (ii) a payments crisis due to a combination of global and domestic factors. These problems worsened due to the pandemic.
2. The situation today is similar to the crisis of 2018, when Pakistan’s foreign exchange reserves plummeted to multi-year low.
3. As of November 19, 2021, Pakistan’s entire liquid foreign reserves stood at $22.773 billion (State Bank of Pakistan (SBP) data - the country’s central bank). Of this, $16.254 billion was held by the SBP; the remainder was with commercial banks. The SBP’s reserves declined by $691 million during the week ended November 19, primarily on account of external debt repayments.
4. Pakistan’s annual economic growth in calendar year 2018 was 5.8%, but fell to 0.99% a year later, and further to 0.53% in 2020 (the World Bank data).
5. This led to a building-up of deficit on the current account, which is the difference between a country’s import and export of goods and services, and includes net transfers such as foreign aid (in any particular period).
6. A persistently high deficit can lead to an excess supply of a country’s currency in its foreign exchange market, which negatively impacts the value of the currency. And the Pakistani rupee has been in a tailspin.

• Seeking help from IMF: As growth reduced and debt services obligations mounted, Pakistan was faced with a balance-of-payments crisis.

1. A BoP crisis happens when a country is unable to finance its import bills or service its external debt.
2. Pakistan imports most items of domestic consumption, making it more vulnerable to these pressures; the increasing debt servicing obligations have added to the pressure.
3. In 2019, Pakistan sought help from the IMF, like it has 13 times over the last four decades. In exchange for a $6 billion funding package, Pakistan had to commit to structural reforms and reducing public debt. But the funding plan stalled earlier this year over issues related to reform commitments, and an agreement could be reached only on November 22.
4. That same day, Shaukat Tarin, who is equivalent to Pakistan’s finance minister, pledged to undertake four other actions: withdrawal of tax exemptions and subsidies, an increase in levy on petro products, higher power tariffs, and an audit of some $1.4 billion in “extra funds” lent to Pakistan in April 2020 in view of the pandemic.
5. Pakistan’s government bonds reacted the day the deal was finalised, jumping between 1.3 and 2.8 cents on the US$, their best day in over a year.

• Seeking help from the Saudis: On November 27, 2021, Pakistan clinched a $3 billion loan from Saudi Arabia as its cabinet approved an agreement to keep the amount in the central bank. In November 2018, Pakistan had inked a $3 billion loan, from which about $1 billion was reported as having been disbursed.

1. Under the new arrangement, the $3 billion from the Saudi government would remain in the SBP’s deposit account for a year
2. Pakistan was expecting to get $7 billion from three sources over the next 60 days, including $3 billion in deposits from Saudi Arabia, a $1.2 billion Saudi Oil Facility with deferred payments, a $800 million Islamic Development Bank oil facility.
3. All of these dollar inflows may be sufficient to alleviate pressure on the country’s import bills. But the loan deal with Saudi Arabia comes with extremely stringent conditions, including record high interest rates of nearly 4%, default clauses that are near draconian, and restrictions on the legal recourse Pakistan will have against any Saudi claim.

• Rising inflation: Pakistan’s record inflation is pushing up the price of daily staples amid mounting threats of unrest. Headline inflation reached 11.5% in November, up from 9.2% in October. Annual food inflation has been in double digits in most months since mid-2019, surging to as high as 23.6% in January 2020, 17.8% in July 2020, and 15.9% in April 2021, according to the State Bank of Pakistan quoted by a November 17 World Bank paper. November marked a return to double digits. Much of the burden of this falls on the poor as higher prices put protein and vitamin-rich foods out of their reach.

1. While inflation is also driven by global commodity prices, regressive domestic policies have not helped matters either, with Islamabad having “systematically penalised the production of high-value products by focusing support on wheat and sugarcane”
2. As a result, Pakistan remains an importer of horticultural products, dairy products despite having a massive number of animals producing below potential, and cotton to feed the domestic textile industry
3. As far as balance of payments is concerned, Pakistan’s current account deficits in September and October have been way larger than anticipated, reflecting both rising oil and commodity prices and improving domestic demand.

• Road ahead: Pakistan is expected to grow about 5% in fiscal year 2021-22 (July-June annual cycle), a four-year high and this growth is reflected in robust and brisk demand of even non-energy imports in Pakistan. On November 24, the SBP raised its policy rate by 150 basis points to 8.75%, stating that “risks related to inflation and the balance of payments have increased while the outlook for growth continued to improve{. The bank also lifted the cash reserve requirement for commercial banks by one percentage point, the first such move in over a decade. Clearly, the Pakistani state has its task cut out for the coming quarters.
• EXAM QUESTIONS: (1) Explain the structural reasons Pakistan is struggling on the economic front. (2) What is the nature of economic help that IMF and Saudis have rendered Pakistan? Explain. (3) If you were the key policymaker for the Pakistani economy, what ten steps would you take to help it recover from the persistent inflation and BoP crises? Explain.

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