Mother of Crisis

The million-dollar question: The current economic crisis could be an opportunity for Pakistan? All crisis may offer an opportunity, but when the same crisis reoccurs after every few years, more than twenty-two times in our case (as that is the number of times we have approached the International Monetary Fund for a bailout package), there is an assertion that the economic policymakers have given up on all opportunities to escape from the crisis. The following analyses the extent of the challenge for the policymakers.

The foreign currency reserves held by the State Bank of Pakistan (SBP) on March 3rd, 2023 were reported at $4.3 billion, approximately $1.4 billion more than $2.9 billion reported on February 3rd, 2023. The foreign exchange reserves held by the SBP had previously dipped to such levels in end 2013, when the government once previously entered negotiations with the IMF. Although, the recent upward trend is due to the inflow of foreign funds in the form of commercial loans from China and a likely precondition of the staff level agreement with the IMF, the foreign currency reserves must be further beefed up. In normal times, an increase in the foreign exchange reserves should bring a much-needed stability in the currency market as it reduces speculation in the currency market. However, the government is unlikely to intervene in the foreign currency market as it may violate its terms and conditions of the staff level agreement. The recurring crisis which involves a decrease in the foreign exchange reserves and the need for IMF financing raises certain questions about the performance of the Pakistani economy.

According to the data extracted from the SBP, the total external debt and liabilities of Pakistan was approximately $126 billion in the end of calendar year 2022. The external debt at the end of the fiscal year 2022 was more than $130 billion. Pakistan paid off approximately $2.7 billion worth of commercial loans in the first six months of the current fiscal year. The external debt in terms of GDP at the end of the last fiscal year was about 40 percent. The total debt servicing, which includes principal and interest, in the second quarter of FY23 was $6.8 billion, which was approximately $3.3 billion more than the amount of debt serviced in the first quarter of FY23. The principal at $5.2 billion, is the highest amount of principal paid in a quarter by Pakistan. Even during the previous balance of payment crisis in 2019, the principal paid was below $3.3 billion. Further, it is expected that Pakistan will need to service more than $20 billion worth of its debt in the next 12 months, which will further increase the pressure on already dwindled foreign exchange reserves. Therefore, the main question should focus on the external debt crisis that recurs every few years as Pakistan struggles to meet its external debt obligations.

The balance of payment crisis takes its root in the current account deficit as the dollar receipts flowing into the country are insufficient to make the payments to external creditors. Pakistan had a current account deficit of $12.2 billion in calendar year 2021, which decreased to $11.9 billion in calendar year 2022. The current account deficit is driven by the trade deficit, which according to the SBP exceeded $37 billion in 2022. The trade deficit is countered by worker remittances, which was approximately $29.5 billion in 2022 and inflow from foreign direct investments, which is unfortunately insufficiently low. When receipts fall short of payments to external creditors, Pakistan either has to seek external sources of financing to pay off its immediate debt or ask its creditors to restructure or rollover its loans. When options are limited, the threat of default on its external payment looms big. In essence, without sustainable sources of dollar inflows into the country, Pakistan once again faces an economic crisis. As a significant portion of the federal budget is allocated towards the servicing of external debt and obligations, the challenges spill-over into the domestic economy. With low levels of tax revenue generation, the vicious cycle continues as the government struggles on the external as well as the fiscal accounts.

The business confidence is at the lowest level in recent years. According to the Business Confidence Index published by the SBP in collaboration with the Institute of Business Administration, Karachi, the overall business confidence index has been in the negative zone since June 2022, when it collapsed from 55.2 points in April 2022 to 42.2 points. This marked the decline in confidence of the businesses and industries in Pakistan. The index was reported at 38.7 points in February 2023, which is at the same level when the COVID-19 pandemic hit Pakistan in March 2020 and a nationwide lockdown was imposed. These are ominous signs and the sharp loss in business confidence does not bode well for a government in an election year. The capacity utilization of the manufacturing sector was at 70 percent in February 2023, a fall from the peak at 80 percent in April 2022. It was approximately 65 percent in October 2022, around the same levels reported during the lockdown due to the COVID-19 crisis. This suggests that the economic conditions are more dire than they were when nationwide lockdown was imposed to curtail the spread of COVID-19. The extent of the external challenges are much worse today than they were in mid-2020.

Although, high levels of imports in relation to exports is the driving force behind the balance of payment crisis, the issue is that it is the low level of exports that needs to be addressed rather than imposing restrictions on imports. The total trade of Pakistan is approximately 30 percent of the GDP, with imports constituting more than 2/3rd of the ratio. Exports, on the other hand, perform dismally low with exports as a percentage of GDP for Pakistan being comparable to some of the poorest sub-Saharan African countries and least developed countries. In essence, Pakistani exporters struggle to sell their products in foreign markets. One major factor that results in such a struggle is the lack of productivity in its manufacturing sector. While Vietnam and Bangladesh were able to increase their manufacturing value added per capita more than six times in the last two decades, Pakistan has failed to even double it. The lack of productivity of Pakistani producers makes them uncompetitive in the global market as the value contributed by each worker is much lower than that reported by regional counterparts. Further, the level of protection offered to Pakistani industries in terms of tariffs and subsidies makes them inward looking and reduces the competitive pressure on the businesses, further increasing inefficiencies. In addition, the trade costs are high as Pakistan has failed to negotiate free trade agreements and participate in multilateral agreements that reduce trade and transit costs. Lastly, there is little focus on the quality of products developed in Pakistan, which limits the ability of Pakistani exporters to sell in markets that now impose more stringent technical measures on the imports.

In summary, there is an urgent need to rethink our policies, particularly those focusing on trade. This is imperative to escape the vicious cycle involving the balance-of-payments.