Pakistan on the Verge of Default
Pakistan, home to a population of approx. 2.8 million is on the edge of bankruptcy. Containers of necessary food products, raw materials, and medical equipment are being held up at the Karachi port because the state is unable to pay for imports. Banks have declined to renew importers' letters of credit.
In the week ended on Feb. 3rd, the foreign exchange reserves held by the central bank fell by $170 million to $2.9 billion.
Negotiations between the nation and the International Monetary Fund (IMF) are ongoing to disburse desperately needed funds under a stalled bailout agreement.
The Country is experiencing severe political turmoil. The economic instability was heightened by the global economic instability caused by the Ukraine war.
Devastating floods between June and August 2022 have triggered a tragedy that has been years in the making - from a weak business climate to malfunctioning domestic energy markets and inadequate tax collection to gloomy foreign direct investment; all factors have contributed to the crisis.
For the ninth review of the aid package, negotiations between the International Monetary Fund (IMF) team, headed by Nathan Porter, and the Pakistani government, represented by Finance Minister Ishaq Dar, commenced on January 31. However, no agreement has been declared as of yet.
The implementation specifics of these policies will be finalized through virtual conversations in the upcoming days, according to the IMF. The money on the table, which is a portion of a $6.5 billion loan scheme, is still insufficient to restore Pakistan's devastated finances.
The situation can be summarised as under
A financial default has become more likely in the fifth-most populous nation in the world, echoing stories from Venezuela and Sri Lanka.
Regarding the US dollar: For several weeks, the Pakistani Rupee has been losing value rapidly. On February 11, the Pakistani Rupee dropped to 271.50 to the dollar in the interbank market.
Discussion over the withdrawal of the 5,000 note: In order to stabilize the economy, the Pakistan Business Council has advised doing away with its highest denomination bill, the 5,000.
Pakistan's inflation is at its highest level in 48 years. Foreign currency reserves currently cover only one month's worth of imports. In January 2023, the Consumer Price Index index rose by 27.6%. Within the same time frame, the Wholesale Price Index rose to 28.5%.
The cost of basic goods like wheat, onions, gas cylinders, etc., has grown as a result of rising inflationary pressure. In January 2022, a 20 kg bag of wheat flour averaged 1,164.8 Pakistani Rupees (PKR). This skyrocketed by 50% in January 2023, reaching PKR 1,736.5.
IMF-Pakistan discussions broke down: Pakistan and the IMF could not agree at the staff level on a crucial $ 1.1 billion bailout plan meant to keep the nation from falling bankrupt. If the IMF does not release funding for Pakistan, the Country's reserves have dropped below USD 3 billion, then default on its external debt is feared.
Though IMF's funding will prevent the default for some time, but the bailout will levy additional taxes and conditions - bringing with it a wave of price increases. Pakistan signed an IMF program worth $6 billion in 2019, which increased to $7 billion the following year. Pakistan has received 13 IMF bailouts since the late 1980s.
Pakistan's gas stations are empty: Last month, the majority of Pakistan's Punjab region's gas stations ran out of fuel, disrupting daily life for the locals. Shahdra, Wagah, Litton Road, and Jain Mandar are some of the locations where the gas stations are shut off due to a lack of fuel. Notably, the economic crisis and currency devaluation have Pakistan's oil firms on the point of "collapse."
Power outage: The "national grid" collapsed last month, causing widespread power outages throughout Pakistan. Karachi, Islamabad, Lahore, and Peshawar all experienced outages.
Pakistan's economic predicament is a result of its high reliance on imports. The trade gap has widened in recent years as Pakistan's imports have increased significantly while exports have virtually stagnated. Pakistan's exports are primarily made up of commodities relating to agriculture and textiles and are not technologically sophisticated.
Rise in Pakistan's debt, debt servicing costs in Pakistan are also increasing. As a result of heavy borrowing, overall debt and liabilities in FY22 totaled Pakistani Rupee 59,697.7 billion (89% of GDP). China is responsible for around 35% of Pakistan's unpaid bilateral debt as of March 2022.
Way Forward?
How can this tsunami of defaults and rapidly declining foreign exchange reserves be prevented?
As a debt-trapped nation, Pakistan must make some significant changes in order to avoid living paycheck to paycheck. Import bans are an example of a populist move that is foolish and ineffective because it raises the cost of living by increasing inflation. Sri Lanka's experimentation with the import ban strategy to stop the loss of foreign exchange reserves proved to be a catastrophic failure.
The Country must concentrate on curbing wasteful spending, such as subsidies and non-developmental military budgets.
In addition, Pakistan requires a methodical and focused approach to address the issue of tax evasion and stop the leakage of millions of dollars in untapped revenue.
Only with the influx of foreign currency and/or the cessation of outflows would the pressure on the Rupee subside. In this regard, the government must devise creative solutions to stop the smuggling of money and other commodities over international borders.
In order to reduce the financial and economic costs of a crisis, Pakistan also needs a solid macroeconomic and financial regulatory framework.
The expansion of chaos and uncertainty in an economy is significantly influenced by information flow. The government must engage in honest public communication through media experts committed to providing accurate economic reporting in order to prevent the spread of disinformation.
The political parties should exercise restraint in this chaotic situation and take decisive action to break the impasse that has raised the clouds of unease and uncertainty.