Pakistan Crisis : A Story of Mismanagement and Wrong Priorities

Pakistan’s solvency has come at stake. The Camel has come under the mountain. On March 28, the Asian Development Bank report said that Pakistan’s debt-to-GDP was the highest in the region at 86 percent in 2019, which further increased to 88 percent in 2020. An ADB Institute report titled “COVID-19 and Economic Recovery Potential in the CAREC Region” stated that Pakistan has the third highest debt service that was, $15 billion or nearly 7 percent of the total for the CAREC (Central Asia Regional Economic Cooperation) region in 2020. The country is facing rising inflation, currency devaluation, unbearable foreign debt, depleting foreign exchange reserves, growing fiscal imbalances and dwindling foreign direct investments. Revenues generated by the government are largely consumed by debt servicing and meeting current expenditure. Pakistan’s debt quantum is increasing at an abnormal and alarming pace.

 Meanwhile, Imran Khan’s coalition lost its majority in the national assembly last week and the opposition moved a no confidence motion in the Parliament. However he avoided being dismissed as the the deputy speaker blocked a no-confidence motion against him and the president dissolved parliament and ordered fresh elections.

In view of this ongoing constitutional crisis and announcement of early elections, the International Monetary Fund (IMF) has put on hold the loan programme for Pakistan with a positive note that it will restore the same once new government is in place. This decision will certainly affect the balance of payment situation and Pakistan’s financial needs on external front. There is a risk that other lenders might also follow the same path, thus, creating a severe financial crunch.

National Address by Prime Minister Imran Khan

In a live-address to the nation ahead of the no-trust motion on Saturday, 69-year-old Khan said (April 8) that he will not accept any “imported government” in Pakistan. He also expressed disappointment over the Supreme Court’s verdict on the National Assembly deputy speaker’s controversial decision on the rejection of no-trust motion against him. In his national address he compared Pakistan and India and said, “Indians are khuddar quam (very self-respecting people). No superpower can dictate terms to India.” Raising the foreign hand charge again, Imran Khan said both India and Pakistan got their independence together but Islamabad gets used as tissue paper and thrown away by the hand of foreign forces. He also lashed out at PML-N chief Shehbaz Sharif, who is the opposition’s choice for Prime Minister. He said, “We have leaders who say beggars are not choosers…he can sacrifice Pakistan’s everything for the sake of his money.”

 He also asked his supporters to join him on the street on Sunday evening as it looks certain that he would lose the no confidence motion and would be dismissed. In his national address, while pointing out at the “rampant horse-trading in the opposition camp”, Imran Khan asked: “Which country’s democracy allows these kinds of acts?” “I am upset that when these things are happening openly, I have never seen something like this happen in a Western democracy. I have never seen people sell their conscience. The Supreme Court should take suo motu cognizance of such activities,

How it all began?

Imran Khan Government suffered a setback on April 7 as Pakistan Supreme Court set aside the ruling of the Deputy Speaker in which he had rejected the no-confidence motion brough by the opposition. The court set aside the dissolution of the Pakistan National Assembly and all the subsequent decisions taken. It also declared that the Prime Minister and federal ministers, ministers of state, advisers stand restored to their respective offices as on April 3. Further, the court gave directions for holding the sitting of the National Assembly “not later than 10:30 am on April 9” for the no-trust vote.

Background of Pakistan Crisis

The current political crisis has been brewing for the past several months.  Pakistan’s economy post Covid-1 pandemic did not really pick up due to complexity of its economic problems and political uncertainty. Pakistan’s falling foreign exchange reserves, rising current account deficit and increasing commodity prices have become defining feature of the economy for the past several months. And now the situation has worsened further. Foreign investors pulled out money from the stock market and bonds at the fastest pace in two years in March. They withdrew investments worth USD 393 million in the same month. The rupee has fallen by 16.57 per cent so far this fiscal year. The foreign exchange reserves held by the State Bank of Pakistan (SBP) declined 19.5 per cent to USD 12 billion in the week ending March 25 due to repayment of external debt, including repayment of a major syndicated loan facility from China.

Pakistan’s economic situation worsened in 2019 to such an extent that it had no way but to seek assistance from the International Monetary Fund (IMF). The EFF was approved by the Executive Board on July 3, 2019 for SDR 4,268 million (about US$6 billion at the time of approval, or 210 percent of quota). The program aims to support Pakistan’s policies to help the economic recovery from the COVID-19 pandemic, ensure macroeconomic and debt sustainability, and advance structural reforms to lay the foundations for strong, job-rich, and long-lasting growth that benefits all Pakistanis. The EEF’s tenure was agreed for a 39-month. But EFF assistance from the IMF comes with conditionality. since the inception of the EFF Pakistan has been struggling to fulfill  IMF conditionality, and has succeeded only partially.

In the 6th review, the IMF Executive Board also approved Pakistan’s request for waivers of applicability and nonobservance of performance criteria.  In the review the IMF noted that Pakistan entered the Covid-19 pandemic with strengthened buffers and “a strong economic recovery has gained hold since summer 2020, benefiting from the authorities’ multifaceted policy response to the unprecedented shock.”But “external pressures started to emerge in 2021, including a widening current account deficit and depreciation pressures on the exchange rate which also reinforced domestic price pressures.”

The IMF, however, warned that “Pakistan remains vulnerable to possible flare-ups of the pandemic, tighter international financial conditions, a rise in geopolitical tensions, as well as delayed implementation of structural reforms.”

In the sixth review the IMF board appreciated Pakistan’s measures to strengthen fiscal policy and put public finances on a sounder footing and the adoption of amendments to the central bank Act as a welcome step toward strengthening its independence to pursue its mandates of price and financial stability. But it suggested that careful spending management and revenue mobilization will help Pakistan to create space for much-needed spending on infrastructure and social protection, while improving debt sustainability. It also suggested that maintaining the momentum on the reform of personal income taxation and harmonization of general sales taxes was essential.

The IMF board expected Pakistan to do further and broader reforms in tax administration and public financial and debt management to further improve the fiscal framework. The board justified the recent monetary policy tightening as necessary and  said that continued proactive, data-driven monetary policy would help to anchor inflation. It also suggested that closer oversight of financial institutions to ensure they remain well capitalized would help to maintain financial stability. Preserving a market-determined exchange rate is crucial to absorb external shocks, maintain competitiveness, and rebuild reserves. The authorities are committed to removing the existing exchange restrictions and multiple currency practices when BOP conditions stabilize. But the IMF board suggested that “Strong efforts to advance electricity sector reform are needed to restore the sector’s financial viability and address adverse spillovers on the budget, financial sector, and real economy. The IFI-supported Circular Debt Management Plan (CDMP) will help to guide the planned management improvements, cost reductions, alignment of tariffs with cost recovery levels, and better targeting of subsidies to the most vulnerable.

The IMF added, “Ambitious steps to remove structural impediments and facilitate structural transformation remain essential to boost growth and job creation and improve social outcomes. The authorities are focused on state-owned enterprises reform, fostering the business environment and reducing corruption, promoting financial inclusion; and addressing the challenges posed by climate change.”

However, Pakistan could not manage to complete the seventh review meeting with the IMF. The PM’s relief package after the post Covid-19 outbreak was the start, where the IMF conditions were disregarded, which delayed the seventh review of the IMF’s Extended Fund Facility. Pakistan and the IMF were holding virtual review talks with the schedule to hold parleys from March 4 to 16, 2022 with the expectation that they would be able to strike a staff-level agreement. The seventh review is yet to be completed due to relief package and industrial promotion package offered by the Pak government. Amid rising political temperature, it was expected that both sides would not be able to strike staff-level agreement under the seventh review so the parleys will continue lingering on till the political dust is settled in the wake of no-confidence move against Prime Minister Imran Khan.

The economic challenges

According to the State Bank of Pakistan (SBP) data, the government’s total debt stocks rose by 8 per cent in the first half of the current fiscal (2021-22) which increased the total domestic and external debt to an all-time high of Rs 51.724 trillion in December 2021, up from Rs 47.931 trillion in June 2021. Continued borrowing from domestic and external resources for financing the fiscal deficit is increasing the country’s debt burden.

The external debt included Rs 14.814 trillion of government external debt, Rs 4.223 trillion non-government debt, and loans of Rs 1.188 trillion from the International Monetary Fund (IMF).

IMF released (February 2) a fresh tranche of loans to the tune of USD 1 billion to Pakistan after the sixth review of the International Monetary Fund’s Extended Fund Facility, subject to fulfilling certain conditions. Fuel prices and power tariffs in Pakistan are at historic highs as a result. The fresh funds constitute an installment of a USD 6 billion bailout package which the IMF’s Executive Board had cleared in July 2019. The country is in a debt trap and the Imran Khan government is looking for new debt instruments. He is also struggling to find ways to increase Foreign Direct Investment (FDI). The existing debt products seem insufficient to meet the growing borrowing requirements and the country is sliding down economic chaos.

Rating agency Moody’s, in its latest report said, the political unrest could slow down the stalling reform drive in the country and was ‘credit negative’. This raises significant uncertainty over policy continuity, as well as the government’s ability to continue to implement reforms to increase productivity growth and secure external financing, including from the IMF. Analysts observe that in the interim (until the IMF programme is revived), there can be difficulties on the external front, which will put pressure on the currency. The role of China will also be critical.

The immediate term help to Pakistan is expected from the EFF of the IMF. There are three outstanding reviews including the seventh, eighth, and ninth of the IMF programme under the existing EFF arrangement which would expire by September 2022. Now both sides were conscious of the fact that there is no liberty available to them for extending talks for months so they will have to conclude the ongoing talks soon to meet the deadlines of the programme. The political uncertainty has interrupted the seventh review meeting with the IMF.

As Pakistan and the IMF team have so far failed to strike a consensus on the MEFP mainly because of rising twin deficit projections, the prescriptions for tackling the budget deficit and current account deficit could not be evolved on policy measures in the shape of tightening monetary and fiscal positions.

The things are even otherwise are difficult for Pakistan. On the economic front, the IMF is also coming up with a prescription of tough prior actions in the shape of rising twin deficits including the budget deficit and the current account deficit. The IMF had envisaged the current account deficit at $12.2 billion on eve of the sixth review but it had already touched $11.6 billion for the first seven months of the current fiscal year. The budget deficit is all set to go up beyond 7% of GDP, equivalent to Rs4.4 trillion, the highest ever absolute figure during the current financial year. In order to curtail the twin deficits, the IMF’s prescriptions clearly illustrate the tightening of fiscal and monetary policies as well as exchange rate adjustments in the range of Rs185-190 against the US dollar.

The indicative target for Net International Reserves (NIR) might be another thorny issue between the two sides. The IMF is also suggesting hiking discount rates and abolishing tax exemptions for individual taxpayers under Personal Income Tax (PIT) and also reducing the number of income tax slabs.

Looking forward

Although just after February 2 meeting the IMF had predicted that Pakistan’s economy is set to keep on recovering in fiscal year 2022, with real GDP growth projected at four per cent, much water has flown in the Indus since then. The political instability may jeopardize even this conservative estimate.

At that time the IMF had praised that the Pakistani economy had continued to recover despite the challenges from the Covid-19 pandemic, but also warned that imbalances had widened, and risks remained elevated. The same remains true even now when PM Imran Khan is facing a no confidence motion today i.e April 9, in the Parliament. The IMF had welcomed in the sixth review the  efforts of Pakistan  to strengthen economic resilience, it said that timely and consistent implementation of policies and reforms remain essential to lay the ground for stronger and more sustainable growth. That is easier said than done in a sharply divided country with multiple power centres.

Pakistan needs to improve its fiscal discipline. Pakistan’s debt to GDP ratio significantly increased in 2020, violating the Fiscal Responsibility and Debt Limitation Act, 2005, prescribing 60% limit. An ADB report says that debt-to-GDP ratio should be decreased to 64% by 2030 by maintaining the primary balance at a level close to zero. It emphasises that the sustainable debt level will be achieved if GDP growth is higher than 4.5% annually. ADB report further said that debt-to-GDP ratio will increase in the case of a negative primary balance and with a historical real interest rate of 2.7%, 10% GDP growth will be required to achieve requirements of the Fiscal Responsibility and Debt Limitation Act, 2005 by 2030. It said that in the last three and half years, the PTI government remained on generating maximum revenue by extracting the most from the existing taxpayers as well as imposing additional taxes but not curtailing unproductive expenses. Resultantly, economic activities declined, and inflation soared. These challenges are mammoth, but not insurmountable if the government adopts right policies.

For this Pakistan needs to set its priorities right.  It aspires to become a regional power, but for this it needs to achieve many milestones such as feeding and educating its people well, developing infrastructure and health facilities, and making a base for a modern economy by diversifying its industrial sector as well as spending on research and development rather than on tanks and guns. Pakistan by shunning manufactured rivalry against India could reap benefit by economic engagement with the latter, the fastest growing economy of the world.

A quick resolution and early election will allow the new democratically elected government to take the much needed tough economic decisions,” the analysts added.