How Politics Holds Back Pakistan’s Economy

Angry and disillusioned. This is the prevalent sentiment across much of Pakistan, especially in Punjab, the country’s heartland. Stoked by a years-long economic crisis that has pushed millions below the poverty line and an electoral process that was neither free nor fair, discontent continues to grow. While the formation of a new government following elections and the continued imprisonment of former Prime Minister Imran Khan has created an illusion of stability, the country remains on the boil from Peshawar to Gwadar and Islamabad to Karachi.

In just the last month, citizens in Pakistan-administered Kashmir have protested against rising inflation – more than four people have been killed – while farmers in Punjab, the country’s most populous province, have been on the streets, too. These events occurred despite a decline in inflation, which has come down from a peak of 38 percent in May 2023 to around 17 percent in April 2024, and a stabilization of the currency.

While the near-term economic stability has calmed nerves, the country will require additional injections of liquidity from multilateral and bilateral institutions in the coming weeks. To unlock these flows, Pakistan is engaged in early conversations with the International Monetary Fund (IMF) to negotiate another program, which will likely include additional austerity and taxation measures. As a result, it is expected that ordinary citizens are likely to face additional pain in the coming weeks, testing the political stability of Shehbaz Sharif’s new government.

An ongoing crisis is roiling the judiciary as well. Six judges of the Islamabad High Court (IHC) have formally complained to the Supreme Judicial Council (SJC) – a body of the superior judiciary – about the executive’s interference in judicial affairs. Political leaders, some of whom are believed to be close to the military, are now publicly targeting judges, prompting a supreme court judge to ask the attorney general of Pakistan whether the government has “started threatening the judges through proxies?”

It is not Sharif but General Asim Munir, leader of Pakistan’s army and inarguably the most powerful man in the country, who needs this new variation of a hybrid democracy to resolve the ongoing economic crisis in Pakistan. Since being appointed army chief in November 2022, Munir (and by extension the Pakistan Army) has taken even more control of policymaking in the country, especially in the economic domain. As a result, resolving the multifaceted crises across the political economy is not only critical to calming ordinary people, but to instilling some level of confidence within the military itself.

A minefield, however, lies in the way. Institutional distrust – in particular between Sharif’s party, the Pakistan Muslim League-Nawaz (PML-N), and the Pakistan Army – and political infighting are likely to blow away even the best laid plans of those running Pakistan today.

Imran Khan’s growing popularity and his party’s successes in the February general elections also continue to worry his opponents, particularly PML-N chief Nawaz Sharif – the older brother of Shehbaz – whose political base in Punjab, ruled by Nawaz’s daughter Maryam, is simmering with discontent. Nawaz will not be keen to let his party bear the political brunt of tough economic choices that only strengthen his opponents, especially Khan’s Pakistan Tehreek-e-Insaf (PTI).

With Khan in jail, Munir and his political allies are seen to have the space and time to do as they please. But while this may seem like the case on the surface, the fact is that every day that Khan spends in jail strengthens him and his party’s future position in Pakistan. This has led to “a confrontation between the state and the people,” in the words of journalist Arifa Noor.

In a country where the political sands – and the mood of the military – can shift in the blink of an eye, Shehbaz Sharif must turn the tide around before he and his government face a reckoning from the military that helped bring them to power in the first place.

An Economic Crisis Birthed by Terrible Politics

The ongoing polycrisis in Pakistan can be traced back to at least 2017, if not earlier. At that time the PML-N, the largest party in parliament, and its leader, Nawaz Sharif, were on the receiving end of pressure exerted by country’s military leadership. Differences on a whole host of issues, key among them Pakistan’s relationship with India, and a mutual distrust between Nawaz and the Pakistan Army were the underlying causes. But the Panama Papers revelations gave Nawaz’s opponents an opportunity to cut him down to size. Removed as prime minister and disqualified for life from holding office, Nawaz and his party’s stars were on the decline.

The 2018 general elections saw the rise of Imran Khan and his PTI, which formed a government with the support of coalition partners in parliament. Khan’s path to power was paved by the military, which felt that he would be a better partner than Nawaz.

But Khan’s chaotic style of governance and his growing reliance on the military to do his political bidding strained the relationship. The military’s patience finally ran out when Khan tried to intervene in its affairs by preemptively signaling that he would pick General Faiz Hameed – a trusted general running the Inter-Services Intelligence (ISI) – to be the next army chief. For an institution that historically selects prime ministers, the mere signal that a civilian prime minister would intervene in the army’s own internal affairs was a step too far. Khan’s political opponents, led by the PML-N and the Pakistan Peoples Party (PPP), aligned with the military leadership, ultimately ousting Khan through a vote of no confidence on April 10, 2022, a historic first.

Khan refused to go without a fight. On his way out he froze energy prices, leaving the incoming government with a ticking economic time bomb. Once ousted, he took to the streets, pushing a conspiracy theory that opposition politicians and the military leadership had schemed with the United States to oust him. Deeply unpopular prior to his ouster, Khan’s rallies were attended by tens of thousands across the country. The new government led by Shehbaz Sharif failed to get a grip on the economy, and rising inflation added momentum to Khan’s rising popularity.

By November 2022 it was time for a change of leadership in the Pakistan Army, with General Qamar Javed Bajwa set to retire. As Bajwa’s retirement neared, there was a lot of intrigue about who would be the next army chief – it was also reported that Bajwa was angling for yet another extension to his term, something that has become a tradition for army chiefs.

Complicating matters further was Khan’s toxic relationship with General Asim Munir, whom Khan had replaced with Faiz as director general of the ISI when he was prime minister. While no official reason was given for this decision, there were reports of growing differences and an alleged fallout over Munir’s corruption investigation into Khan’s wife. In the run-up to the change of leadership, PTI leaders would openly tell individuals, including this author, that Munir would never be acceptable to Khan and the PTI as army chief.

The decision to appoint an army chief ultimately rests with the prime minister, giving the ruling PML-N an opportunity to pick a general who at the very least did not have a soft spot for Khan. After weeks of speculation, the ruling party decided to pick Munir as the next army chief.

With Munir at the helm of Pakistan’s military apparatus, Khan’s odds to become prime minister once more were falling fast. Following Khan’s arrest on May 9, 2023, riots erupted across Pakistan, especially in Punjab and Khyber Pakhtunkhwa. Rioters attacked several military installations and also entered the Lahore Corps Commander’s residence, ransacking and burning it.

What followed was a major crackdown against the PTI, which alleged that the May 9 events were a “false flag” operation. While the PTI has continued to demand an inquiry into the events leading up to and on the day of the riots, the military used the event as a means to cut the PTI down to size.

When parliament’s tenure ended in August 2023, the military got another opening to recalibrate. Pakistan’s constitution stipulates that elections must be held under a caretaker government – an interim setup that includes independent, reputable individuals whose job it is to oversee the conduct of free, fair, and credible elections. Given the nature of the political and economic crisis confronting Pakistan, the military found in the interim government a new mechanism to run the country as it desired.

Elections were delayed beyond their constitutional mandate through creative constitutionalism, allowing Munir and the military more time to do what it believed needed to be done before general elections were finally held in February 2024.

Khan went from being the military's favorite politician to being their worst enemy. Meanwhile, an unnatural alliance emerged between brothers Nawaz and Shehbaz Sharif – the latter more desirable to the military than the former – Asif Ali Zardari of the PPP, and the army led by Munir. After years of railing against the alleged corruption and misgovernance of the PML-N and the PPP, the Pakistani military’s leadership had no option but to join hands with its previous enemies as it sought to control Khan and his PTI.

Changes at the Supreme Court worked in favor of this new alliance as well, with Justice Qazi Faez Isa becoming the chief justice of Pakistan on September 17, 2023. Justice Isa had previously been targeted by the Khan government and General Faiz; Khan later called this a “mistake.”

It was this tacit compact between political leaders, the army chief, and the chief justice that helped bring Shehbaz back to power following the February 2024 general elections. However, the process did not proceed as anticipated, primarily because ordinary citizens in Pakistan insisted on making themselves heard; the military’s own long-running campaign to portray Nawaz and Zardari as corrupt, unpatriotic politicians did not aid its cause.

In the run-up to elections, the PTI had its leader in jail, while many others had been forced to either go into hiding or part ways with the party. The PTI was also not allowed to hold public rallies and found its workers arrested and threatened at every turn. And on the eve of elections, the PTI had its electoral symbol taken away by Justice Isa’s Supreme Court, a blow for any party in an electoral system where ordinary citizens vote on ballot papers by simply looking at party symbols.

Despite these odds, however, the PTI’s candidates emerged as the largest single bloc once elections were held. In addition, they alleged that the count was rigged on dozens of seats, a claim that is currently being contested in the courts and that has some validity to it.

An Unpopular Hybrid Regime Embarks on Reforms

This political game of thrones is the underlying driver of the economic, political, societal, and national security crises confronting Pakistan today.

Terror attacks have increased exponentially in Khyber Pakhtunkhwa and Balochistan – historically restive provinces – and the Pakistani Taliban have now started to conduct targeted assassinations in Punjab.

Relations with India are at historic lows and do not show any signs of improving. Meanwhile, Pakistan’s bet on the Afghan Taliban has soured, with Islamabad accusing the Taliban regime of harboring terrorists on Afghan soil and the latter alleging that Pakistan is supporting the Islamic State as part of its strategy to destabilize the Afghan government. As a result, border closures have become the norm and Pakistan has pushed hundreds of thousands of Afghan refugees back into Afghanistan. The relationship with Iran has also become increasingly problematic. Pakistan exchanged missile strikes with Iran in January, becoming the first country to hit Iranian soil since the Iraq-Iran war.

The country’s strategic ally, China, seems to have cooled on Pakistan due to its economic woes and the growing terror problem: There are over $2 billion in unpaid dues to power sector investors from China and terror attacks have targeted Chinese engineers and workers in recent months.

The political chaos has undoubtedly inflicted the highest toll on the economy during this period. Over 40 percent of Pakistan’s population now lives below the poverty line, according to the World Bank. Inflation, which burdens the poorest households the most, is now bleeding the middle and upper middle classes: from January 2019 to April 2024, Pakistan’s consumer prices have climbed by over 127 percent, compared to about 34 percent in India and 43 percent in Bangladesh, according to data analyzed by this author.

In just a few years, Pakistani households have fallen significantly behind their peers, primarily because incessant elite political infighting has led to disastrous economic choices and sustained uncertainty in markets.

Some stability has been achieved in recent months, with inflation coming down to 17 percent in April 2024. Reserves have recovered to around $9 billion, and the currency has stabilized. But this near-term stability is wholly dependent on the continued support of Pakistan’s multilateral and bilateral partners, meaning that the government has its work cut out in the coming weeks.

It is within this political context that the current government led by Shehbaz Sharif – and backed by Munir – must deliver much-needed economic reforms and potentially seek to reorient Pakistan’s foreign and national security policies.

Doing so requires a resolution of the political chaos engulfing Pakistan, both across institutions and within political parties. For example, the ruling PML-N has its own competing centers of power today, with Nawaz Sharif seemingly much less open to allowing the army to have its way than his brother, the prime minister. As a result, Nawaz has tried to claw back some control over the government in recent weeks, appointing his trusted adviser and relative-by-marriage Ishaq Dar as deputy prime minister, while Dar also serves as foreign minister.

Given Dar’s own complicated history as finance minister – his abrasive style and unorthodox policies almost led to a sovereign default in the summer of 2023 – the decision was made to keep him away from the finance ministry this time around. As a result, Muhammad Aurangzeb, a respected technocrat who most recently served as chief executive officer of Habib Bank, the country’s largest bank, was chosen to serve as finance minister.

Aurangzeb is not only respected in the broader business community within Pakistan, but is favorably seen by multilateral institutions, especially the IMF. This is because unlike his predecessor, Aurangzeb has been more open about accepting what ails the economy, and has refused to push for unorthodox solutions to the country’s economic mess.

But while he has so far said the right things, pushing the necessary reforms through Pakistan’s obstructive system, especially its bureaucracy, will remain a challenge. In addition, Aurangzeb will also face internal pressures, with Dar continuing to play an important role in party affairs and having the trust and ear of Nawaz himself.

Finally, to fundamentally alter the country’s trajectory, the finance minister will have to take away many of the benefits that are accrued to the country’s elites, including the military. At a time when the government itself is both unpopular and dependent on military support, it is unlikely that he and his prime minister would want to rock the boat too much.

This then makes it likely that the government will pursue incremental changes, as its predecessors did, that deliver on three key fronts: higher taxes, privatization of some key state-owned enterprises, and securing additional funds from strategic allies like Saudi Arabia.

On the taxation front, successive policymakers have publicly accepted that the real solution lies in broadening the tax base. This can only be done by taxing the real estate sector, bringing retailers into the tax net, and reforming the tax code for agriculture.

All three sectors would hit key constituencies that are critical to both political parties and the military. Real estate has a direct link to the army and its officer class, retail is a key constituency of the ruling PML-N party in Punjab, and well-heeled landlords dominate the National Assembly as well as provincial assemblies in Punjab and Sindh.

Years ago, even the dictatorship of General Pervez Musharraf failed to bring retailers into the tax net. When Shabbar Zaidi, Khan’s tax czar, tried to push new taxes on real estate, then-Army Chief Bajwa told him to back off because his officers were getting upset.

The chances of the PML-N, especially its leader Nawaz, signing off on anything that upsets his key constituents when they are already unhappy remains slim, while Munir will find it difficult to put a halt to trading activities in real estate that benefit the officer class of the armed forces.

This then means that the IMF’s stated goal of having Pakistan increase its taxes by broadening its tax base will be difficult to achieve. As such, the country’s financial managers will find it easier – as they almost always have – to push regressive taxes instead. The IMF is likely to agree to these measures as well, given that they tap into an existing source of tax revenues as opposed to promises of forcing compliance from vested interest groups.

As a result, more indirect taxes on energy, increases in rates for salaried individuals, and an additional burden on formal businesses are likely. These measures have not solved the structural taxation issues plaguing Pakistan in the past, and they are unlikely to lead to any dramatic changes today.

Privatization is another avenue to not only bolster revenues in the short term, but also bring an end to fiscal challenges emanating from financing loss-making state-owned enterprises. In the recent past, the government has signaled a desire to privatize Pakistan International Airlines, the national carrier that is a classic case of how state-owned entities can become a financial pit. While progress has been made when it comes to the organization’s privatization, there is still a long way to go in terms of completing the deal.

The airline is only the first test of the government: privatizing state-owned energy and electricity distribution companies is the bigger challenge. The last wave of privatization occurred during the Musharraf dictatorship when his government privatized the Karachi Electric Supply Corporation. But when Musharraf tried to sell the Pakistan Steel Mills Corporation, the Supreme Court intervened, setting off a series of events that led to Musharraf’s ouster through a lawyers’ movement. Differences within the government over privatization are already coming to the surface.

Unions and other political elements may also align in protest against rapid privatization, and potentially set off unpredictable events that force the government to slow down. Even if this does not happen, vested interests within Pakistan’s byzantine bureaucracy will most certainly slow things down. Over the last few years, for example, the simple privatization of a small hotel in Lahore has been stuck due to bureaucratic and procedural delays.

A Foreign Policy Focused on Securing Bailouts

A critical element of Pakistan’s economic strategy rests on foreign policy, especially as it relates to the additional inflows of foreign currency from strategic allies. Following 9/11, Musharraf’s dictatorship received a lifeline from the West, in particular the United States, a key ally in the war on terror. Once those flows dried up, Pakistan found in China a new economic patron. Beijing lent Islamabad billions of dollars during the peak of the Belt and Road Initiative, of which the China-Pakistan Economic Corridor (CPEC) was a critical component.

These geopolitical rents have propped up Pakistan since its founding in 1947. While elites increasingly highlight that this reliance must end, they seem unwilling to change the structure of an economy that has become addicted to these very same rents.

As a result, Pakistan is now looking at Saudi Arabia as the next major provider of these rents.

This spring, the country has had several high-level engagements with Saudi Arabia to explore investments in Pakistani assets. The deals, however, are yet to materialize. Pakistani stakeholders are confident that the Saudis are likely to invest almost $5 billion in Pakistan, including in the Reko Diq mine located in the restive province of Balochistan, which is currently in the midst of an insurgency. In early May there were indications that Saudi Arabia’s Crown Prince Mohammad bin Salman was going to visit Islamabad to ink these deals, but the trip has been delayed for the time being.

The key issues stalling progress are much the same as those that prevent other forms of foreign investment from coming into Pakistan: macroeconomic uncertainty, political instability, and bureaucratic hurdles. Pakistan has talked of new investments from Saudi Arabia, the United Arab Emirates, and Qatar for years. However, foreign direct investment inflows have continued to remain flat.

The other foreign policy opportunity that can unlock economic benefits lies with the normalization of trade with India. The prospects for this happening, however, remain dim.

While India’s Prime Minister Narendra Modi did try to chart a more positive path forward with Pakistan after coming to power in 2014, he quickly realized that Pakistan’s own dysfunctional politics stood in the way. Since then, the Indian government has taken a much harder stance against Pakistan.

Meanwhile, Pakistan has dug in, unilaterally ending trade with India following its decision to change the status of Indian-administered Kashmir in 2019. To get back to the negotiating table, Pakistan will require some face-saving, something India appears unwilling to provide, as evidenced by remarks made by Modi on the campaign trail last month.

In addition, any major moves on India by the current Pakistani government would bring pushback from the PTI, with Khan likely to argue that an illegitimate government is selling out Pakistan’s interests. The risk of this backlash is also likely to prevent Islamabad and Rawalpindi from making a dramatic break from Pakistan’s traditional India policy.

Incremental Changes, Not Wholesale Reforms

With Pakistan left with few patrons, closing these deals with Saudi Arabia is critical to Shehbaz Sharif and Munir’s domestic political prospects. Both Sharif and Munir recognize that bureaucratic hurdles and procedural delays are a key problem facing the economy. They also know that the Saudis have no love lost for Imran Khan, and are unlikely to invest should political instability roil Pakistan once more.

To bypass these issues, Pakistan formed the Special Investment Facilitation Council (SIFC) in June 2023, when Shehbaz Sharif was heading a coalition government after Khan’s removal. The SIFC gives a formal role to the Pakistan Army in economic policymaking, and has become the nodal organization running economic affairs in the country. While the SIFC seeks to improve coordination and accelerate decision-making, it is also an indictment of Pakistan’s formal governance system.

In recent months, the SIFC has pushed for new projects across sectors including mining, farming, and semiconductor manufacturing. To date, however, nothing major has materialized, leading many to question whether this is an effective way of resolving Pakistan’s economic woes. And there is reason for this skepticism: Under Khan’s hybrid government, the military pushed for a CPEC Authority to streamline issues faced by projects under CPEC. The authority still exists, but no one really talks about it anymore, and it was unable to make any significant headway.

For the time being, Munir and the civilian government are trying to control the discourse by clamping down on freedom of expression on the internet and exerting greater control on the media. This strategy, however, does not seem to be changing the public’s view of the government. While the decision to control the narrative may create the illusion of stability, the government will ultimately need to deliver a tangible improvement in the lives of ordinary citizens in the coming months.

Almost 25 years ago a banker who had taken over as finance minister stood up in parliament to tell Pakistanis that the status quo could not be sustained. He said that “no country can prosper whose citizens acquire wealth and income non-transparently” and argued that “every citizen must share the cost of governance by paying a share of his income.”

The man was Shaukat Aziz, a Citibank executive brought into government by General Musharraf to turn the economy around. During his time at the helm of affairs, Aziz talked about bringing in foreign investment, widening the tax base, and privatizing state-owned enterprises. Pakistan’s complicated politics and its elite’s short-term outlook, however, eventually got in the way. By the time Aziz was leaving Pakistan in 2007, the country was facing an unprecedented economic, political, and security crisis.

Years later, another respected banker, Muhammad Aurangzeb, has taken over the finance ministry. He is all set to make a similar budget speech to parliament, representing yet another government that has serious question marks over its legitimacy.

Whether Aurangzeb and his backers can achieve their stated goals remains to be seen. But the structural impediments that have prevented successive governments from changing course are stronger than ever before. Ultimately, it is politics, not economics, that is preventing a wholesale turnaround of Pakistan’s broader trajectory, especially in the national security and economic policy domains.

With ruling elites relying on short-circuiting the system to enable crisis-mode decision making, sustainability is a fiction. The short-circuiting has only shocked the broader political economy, and not in a good way.

The current hybrid regime, with the full backing of Munir, has a short window of opportunity before its prospects also dim. That window will begin to close soon after the upcoming budget and will firmly shut once the conversation shifts toward yet another extension of yet another army chief in early-to-mid 2025.

Until then, Shehbaz Sharif and his government could make a bold bet across the board by showing some imagination and changing the economic and foreign policy trajectory of the country. This would include wholesale privatization, a complete change of the existing tax code, and reorientation of the country’s industrial and energy policy. It also would require a holistic change of the country’s foreign policy, especially as it relates to India – even unilateral normalization of trade at the moment is in Pakistan’s interest.

Such moves would be a substantial departure from the past and signal that Islamabad and Rawalpindi are serious about changing the status quo. As a result, international investors, including bilateral partners, would be more likely to reconsider their views on Pakistan and its political economy.

To convince outsiders that this time is different, Pakistan’s ruling elites must first credibly signal that they have done away with an incremental approach to policymaking. Embarking on the most serious, wholesale reform of the political economy provides a pathway out of this prolonged crisis. But for the time being, it does not seem as if Pakistan’s ruling elites have the imagination needed to build a new reality and convince their citizens and foreigners alike that this time is different.