Pakistan’s Economy on the Brink of Collapse

Fears are looming that Pakistan may default on its foreign debt as it faces its worst financial crisis in history. The country’s foreign exchange reserves dropped below $11 billion in mid-May, which is hardly enough to cover six weeks of imports. Moreover, the country’s current account deficit has widened to unsustainable levels during the ongoing financial year.

This has resulted in the Pakistan Stock Exchange (PSX) and Pakistan’s currency coming under immense pressure over the last few weeks. The Pakistani rupee crossed beyond 200 against the U.S. dollar in May, while the PSX has been taking a severe battering due to the new government’s inability to make crucial economic decisions.

Much of this new cycle of financial crisis is linked to what is happening in Pakistan’s political battlefield. The Pakistan Muslim League-Nawaz (PML-N) leader Shehbaz Sharif was elected prime minister following the ouster of his predecessor, Imran Khan, in a parliamentary no-confidence vote in April. Before his removal, Khan announced a cut in fuel prices despite a sharp global rise in the cost of oil and decided to maintain the tax amnesty scheme for industrial sectors.

The former premier promised to freeze fuel prices until the next fiscal year budget, announcing that the subsidy would be covered by the government. Many in Pakistan’s policymaking circles have argued that Khan did this as he was aware the no-confidence motion against his government was going to succeed. While the populist move may have been welcomed by Khan’s supporters, it has had a disastrous impact on Pakistan’s economy.

After Khan’s subsidy announcement, the International Monetary Fund (IMF) stopped the seventh review of the $6 billion Extended Fund Facility (EFF), saying that the move cannot be justified. After the removal of the Pakistan Tehreek-e-Insaf (PTI) government, the IMF virtually suspended its program for Pakistan.

The last three months of politics over fuel prices and other subsidies has left little maneuvering space for the new government. As of mid-May, after six weeks in office, Sharif had not been able to decide on a policy to approach the IMF. He wants to revive the IMF’s bailout package to stabilize the economy but doesn’t want to reverse the existing subsidies, fearing that it may have political costs. The new government wants money from international lenders, but is not prepared to implement policies that the previous government agreed to as part of the IMF program.

So far, the new government has not been able to conclude any new loan deals with Saudi Arabia, China, or the United Arab Emirates (UAE). Reportedly, these countries have told Pakistan that reviving the IMF program was important for them to decide on any new loans.

On the other hand, the IMF has reportedly set five conditions for the revival of the $6 billion bailout package, including the reversal of petroleum and power subsidies, and the removal of the tax amnesty scheme. Newly appointed Finance Minister Miftah Ismail has struggled to meet IMF representatives as his government remains in a fix over its policy choices regarding the current economic crisis.

Reportedly, the PML-N is not ready to carry the burden of making the tough choice to reverse subsidies on fuel and wants other coalition partners to support the decision. The party’s leadership likely believes that making an unpopular decision to hike fuel prices close to an election year will only benefit Khan’s narrative and adversely impact the PML-N’s electoral prospects.

It is important to note here that in April, Prime Minister Sharif traveled to London to meet his brother Nawaz Sharif amid reports that the premier was set to have consultations with his party’s chief on the country’s economic situation. Major decisions were expected after the consultations. However, the only major decision made after the meeting was the announcement that all major stakeholders should assist the PML-N in making difficult choices. After returning from London, the prime minister decided to maintain fuel prices, which essentially showed that there was no consensus in the ruling coalition’s ranks over the IMF’s demands.

The IMF’s scheduled talks with the officials of the new government may be in jeopardy. Currently, there are no other major prospects of cash injection into Pakistan’s economy, and if China, Saudi Arabia, and the UAE were to ask for repayment of their loans, which make up most of Pakistan’s foreign reserves, the country could default instantly.

A deal with the IMF is not possible unless the government withdraws the fuel and other subsides. Given the deep divisions within the ranks of the new government over the issue, we could see the prime minister announcing new elections, which could create another crisis as Pakistan is only weeks away from its next fiscal year budget.

The new government doesn’t have the luxury of time. It needs to present a fiscal year 2022-23 budget on June 10. Before that, the country needs an agreement with the IMF to fund everything that is going to become part of the next budget.