Introduction
The Islamic Republic of Pakistan, one of the most populated countries in the world, has been struggling for years due to a persistent status of crisis. This is not only putting more of its citizens in danger of falling into poverty, but it is also negatively affecting the whole South Asian region. Hence, national as well as foreign authorities are negotiating and implementing measures to stabilise the situation. Namely, the State Bank of Pakistan (“SBP”) is targeting the crisis through its monetary policy and the Government is seeking support from foreign institutions, including the International Monetary Fund (“IMF”).
The Islamic Republic of Pakistan, one of the most populated countries in the world, has been struggling for years due to a persistent status of crisis. This is not only putting more of its citizens in danger of falling into poverty, but it is also negatively affecting the whole South Asian region. Hence, national as well as foreign authorities are negotiating and implementing measures to stabilise the situation. Namely, the State Bank of Pakistan (“SBP”) is targeting the crisis through its monetary policy and the Government is seeking support from foreign institutions, including the International Monetary Fund (“IMF”).
Economic development of Pakistan
With around 230m of inhabitants, Pakistan is one of the largest countries in Asia. The state has a long history and a rich culture, but its economy has been a rollercoaster for years, especially since the 2010s. On the one hand, the country that trades on the Pakistani rupee has been on an impressive growth track, but, on the other hand, this upside was often overshadowed by frequent economic crises. Pakistan gained independence from Britain and was separated from India in 1947. Since then, it has undergone various political and economic changes. Even though Pakistan's economy was at first mainly based on agriculture, since the 1960s it began to industrialize, with the Government instituting policies to encourage the development of a strong industrial sector. Subsequently, in the 1970s, major industries were nationalized and then privatized again in the 1980s to revive a struggling economy. During the 1990s, the country implemented several economic reforms, including further liberalization of trade policy and reduction of Government control over the economy, which spurred growth and attracted foreign investment.
From 2010 to 2021, the average annual GDP growth rate was 3.7% and in 2021 peaked at 6.5% (albeit high inflation).
Pakistan GDP Evolution
Source: Refinitiv
Source: Refinitiv
Although Pakistan is still considered a developing country, most of its annual GDP is generated by services (>50% GDP in 2021), followed by agriculture and industry, which in turn is primarily driven by manufacturing (textiles and automotive), mining, construction, and electricity & gas.
The main engine of Pakistan's economic growth is represented by foreign investment, with China being a key player. In fact, the two countries have signed an agreement called the China-Pakistan Economic Corridor (CPEC). The multibillion-dollar project to build roads, railways, and ports connecting western China to Pakistan has the potential to boost Pakistan's economy by creating jobs and improving the lacking infrastructure, which the country desperately needs.
More recently, other countries have stepped up their investments, notably the US, UK, and Japan, stimulating the economy and especially employment. Despite this, the Pakistani economy faced multiple crises. In 2018, the decline in its foreign exchange reserves (caused by exorbitant imports and less-than-projected inflows) almost degenerated when the country sought assistance from the IMF and secured a $6bn bailout. As part of the agreement, Pakistan had to implement a series of economic reforms, including the reduction of domestic and external imbalances, the removal of impediments to growth, the increase in transparency, and the strengthening of social spending. However, this situation also implied a significant increase in foreign debt over the years, reaching around $130bn. It is also critical
6.2%2.5%-1.3%6.5%6.2%-2.0%0.0%2.0%4.0%6.0%8.0%20182019202020212022
to notice that 18 out of Pakistan’s 21 IMF programs over the last 60 years have not been completed despite obtaining over $30bn in financial support. Moreover, since large amounts of Government revenue are spent on debt repayments due to the magnitude of its obligations at the expense of spending on education, social welfare, and development programs critical to long-term macroeconomic growth.
Faced with this mounting debt problem, Pakistan is trying to implement various measures, including reducing public expenditure and increasing its revenue sources but the Debt to GDP ratio remains around 77%.
The main engine of Pakistan's economic growth is represented by foreign investment, with China being a key player. In fact, the two countries have signed an agreement called the China-Pakistan Economic Corridor (CPEC). The multibillion-dollar project to build roads, railways, and ports connecting western China to Pakistan has the potential to boost Pakistan's economy by creating jobs and improving the lacking infrastructure, which the country desperately needs.
More recently, other countries have stepped up their investments, notably the US, UK, and Japan, stimulating the economy and especially employment. Despite this, the Pakistani economy faced multiple crises. In 2018, the decline in its foreign exchange reserves (caused by exorbitant imports and less-than-projected inflows) almost degenerated when the country sought assistance from the IMF and secured a $6bn bailout. As part of the agreement, Pakistan had to implement a series of economic reforms, including the reduction of domestic and external imbalances, the removal of impediments to growth, the increase in transparency, and the strengthening of social spending. However, this situation also implied a significant increase in foreign debt over the years, reaching around $130bn. It is also critical
6.2%2.5%-1.3%6.5%6.2%-2.0%0.0%2.0%4.0%6.0%8.0%20182019202020212022
to notice that 18 out of Pakistan’s 21 IMF programs over the last 60 years have not been completed despite obtaining over $30bn in financial support. Moreover, since large amounts of Government revenue are spent on debt repayments due to the magnitude of its obligations at the expense of spending on education, social welfare, and development programs critical to long-term macroeconomic growth.
Faced with this mounting debt problem, Pakistan is trying to implement various measures, including reducing public expenditure and increasing its revenue sources but the Debt to GDP ratio remains around 77%.
Gross government debt as % of GDP
Source: Refinitiv
Source: Refinitiv
Overview of the current economic and political situation
As briefly mentioned, throughout its history, Pakistan faced numerous economic challenges, but at this moment the country is on the verge of economic collapse. Over the past decades, Pakistan has been accumulating foreign debt (now ~$130bn). In contrast, the country’s central bank’s foreign currency reserves stand only at around $3bn, an amount that barely covers the equivalent of a few weeks of imports. This low figure is mainly due to the historical trade deficit and the constant debt repayments related to the magnitude of the obligations.
This balance of payments crisis is causing several far-reaching problems besides discouraging foreign investment. The current medicine shortage constitutes only one of the several examples of how the crisis is impacting the country. As imports of medication and commodities to produce drugs are interrupted by the lack of foreign currency flows, Pakistan’s supply of simple but vital medicine is widely impacted. A variety of products is already out of stock, with hospitals struggling to give adequate treatments.
In addition, after the central bank removed the cap on the Pakistani rupee, the lack of demand for the currency led to its substantial depreciation, making imports relatively more expensive and thus affecting consumers with higher prices. Moreover, larger import costs also led to an increase in production costs for domestic firms, as they often heavily rely on imported commodities and goods.
Generally, inflation in Pakistan has surged, reaching 31.5% in February 2023, exposing consumers to worsening living standards. In particular, the poorest social classes suffer the most, as spikes in food and energy prices directly affect their everyday necessities. The soaring price levels are not solely due to the rise in import costs, but rather they result from the combination of several factors. Firstly, long-lasting effects from the Covid-19 pandemic played a role, as well as the current conflict in Ukraine, which drove a substantial increase in energy prices. Secondly, last summer’s floods in Pakistan destroyed crops, dwellings and invested capital, leading to an overall food shortage. In addition, the consequent reconstruction effort required the Government to increase its budget deficit. Thirdly, the Government’s efforts to decrease this deficit and to meet the requirements from foreign investors in order to receive further financial aid led to cuts in subsidies, resulting in additional price increases for a variety of goods.
CPI Inflation (%y/y)
Source: Factset
Source: Factset
Pakistan’s critical economic situation, gloomy prospects for the future as well as the rising risk of default are mirrored in the rating downgrade by Moody’s that in February downgraded Pakistan’s debt rating from Caa1 to Caa3 due to its fragile liquidity, significant outstanding debt and high chance of default. As investors were already cautious about investing in Pakistan, the downgrade could further discourage foreign investments or increase the cost of borrowing. All in all, this downgrade adds to the country’s several issues, worsening the uncertainty regarding the future. Decreasing living standards and rising poverty due to the increased costs and the shortage of food and vital imports, terrorism, national wide power cuts.
Central bank’s actions and IMF intervention
Considering the unstable situation described, the State Bank of Pakistan is tightening the monetary policy to stop the rise in prices and to target 8% inflation. The institution was established in 1948 and it oversees the implementation of monetary and credit policy actions considering Government targets for growth and inflation and according to the recommendations of the Monetary and Fiscal Policies Co-ordination Board. The central bank rose the key interest rate to 20% in March 2023, thus making private borrowing more expensive and slowing down the economic growth. According to recent estimations, the Pakistani economy is expected to grow only by 2% in 2023, which could lead to further difficulties in reducing the balance of payments deficit, as well as the Government deficit. This rate increase is considered a necessary action to reduce inflation even if the positive effects of these actions are not immediately visible.
As a more in-depth overview of the central bank's actions, July 2022 was marked by the increase in the interest rates by 125 basis points to 15% in response to the surge in inflation that occurred between May and June (from 13.8% to 21.3%). Despite these corrective actions, inflation reached almost 25% in July, impacting especially food and fuel price levels. Since inflationary pressures were stronger and more pervasive than expected by the State Bank of Pakistan, policy rates were increased further in November and in January, reaching 17%.
In addition to inflation, one of the most urgent concerns for Pakistan is the shortage of foreign currency. In February, ongoing negotiations between Pakistan and the IMF were unable to secure $1.1bn of critical finance to avoid the country defaulting on its obligations. The
conditions imposed by the IMF to finance Pakistan included a market-determined exchange rate for the local currency, the easing of fuel subsidies, circular debt control in the energy sector and the guarantee of full financing of the balance of payments deficit. Since Pakistan's foreign exchange collapsed to around $3bn, the IMF intervention is crucial for a prompt resolution of the crisis related to the balance of payments that the country is facing.
In March 2023, the State Bank of Pakistan lifted the interest rate trying to convince the IMF to unlock the required funds and surprising the markets with an increase of 300 basis points up to 20%, which exceeded expectations of investors polled by Reuters by at least 100 basis points.
Outlook for the future
While in mid-2022 the World Bank expected Pakistan to realise a GDP growth of 4.3%, 4%, 4.2% in 2022, 2023 and 2024, respectively, this picture has recently changed. According to the Economist, the updated 2023 forecast of the World Bank predicts a slower growth rate for the country’s GDP of 2% in 2023 and 3.2% in 2024. The deterioration of the estimates is also related to the devastating floods that extensively affected the country’s agricultural sector, which represents around 23% of Pakistan’s GDP for an overall damage estimated at 4.8% of GDP. Moreover, the situation was exacerbated by the conflict in Ukraine, rising interest rates, inflation, and reduced investments, which produced a long-term slowdown in the expected global growth rate (from the expected 3% to 1.7% in 2023). In fact, the inflation rate in the country is anticipated to remain elevated (around 28 to 30%) over the next several months. The main reasons are the unstable political situation, currency depreciation, rise in energy and administered prices. Experts also note that it will likely take some time before the contractionary monetary policy initiated by SBP produces the desired effects. The updated report also indicated that Pakistan’s economic situation is negatively affecting the growth prospects of the entire South Asian region, whose main growth driver is India.
According to Moody’s, we will not observe “an overnight fix” in Pakistan, and any improvement will be gradual. Therefore, experts believe that the dire economic situation in the country will persist in 2023 and probably 2024. Even though the country is currently seeking an agreement with the IMF to get the necessary funding, the bailout alone is not expected to permanently resolve the situation. This is partially due to the unsuccessful track
record of IMF bailouts for Pakistan. As a result, economists believe that the country requires “persistent and sound economic management”, and that simply injecting funds without a sustainable macroeconomic plan is not going to deliver the desired results.
Nonetheless, a healthy and consistent management is not expected to be implemented any time soon. As in 2022, in 2023 politics are anticipated to consume most of Pakistan’s resources. As the struggle for power continues, the Government is attempting to hold off the elections, that are currently projected to take place in October 2023, to spur a reduction in the economic crisis and in the poor domestic performance. However, despite all the attention currently drawn to politics with the strong protests from the opposition taking place, the results of the elections are unlikely to solve the chronic economic issues. This environment of uncertainty and political instability is indeed considered one of the several obstacles to the country’s potential agreement with the IMF, as the latter is looking for a sound Government capable of implementing the agreement without the interference of the opposition party that, even though is expected to abide by the conditions, might decide to postpone the pledge to complicate the situation for the current Government.
Conclusion
Moving forward, Pakistan is expected to face further economic challenges. Indeed, the financial and economic outlook of the country highly depends on the next political and economic developments. More specifically, based on the outcome of the elections, the results of the central bank policy and the negotiation with the IMF, divergent courses of actions could take place, triggering revisions in economic forecasts by analysts. And even in the case of a successful implementation of the above, the economic recovery would be a long and complex process hard to predict upfront due to the number of variables involved.
By Leo Maximilian Antlitz, Lilit Kalantar, Vittorio Granuzzo, Najwa Sadki
Sources
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https://www.sbp.org.pk
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oss%20economic%20sectors%20Pakistan%202021&text=In%202021%2C%20agriculture%20contributed%20around,came%20from%20the%20services%20sector
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