EXPLAINED: Pakistan's economic crisis and default risk

By Aamir Latif

KARACHI, Pakistan (AA) – Escalating political uncertainty, a balance of payment crisis, severely depleted foreign reserves, and increasingly grim prospects of external financing: Pakistan is presumably sitting on an economic powder keg.

The country has been engulfed by unrest since former Prime Minister Imran Khan was arrested earlier this month.

Arrests, court cases, and the future of Khan and his Pakistan Tehreek-e-Insaf (PTI) party dominate the daily news cycle, but beneath it all lurk persistent fears of a default, an eventuality with repercussions that would be felt far beyond the political realm.

Reports from local and international organizations warn that Pakistan’s economy is on the brink.

Ratings agency Moody’s downgraded the country’s credit rating in February, while more recently it said Pakistan could default as soon as June if it fails to secure an International Monetary Fund (IMF) bailout.

Islamabad has been negotiating with the IMF since early February for the release of $1.1 billion, part of a $6.5 billion bailout package that, ironically, was inked in 2019 by Khan’s government.

To meet the IMF’s stringent demands, Prime Minister Shehbaz Sharif and his coalition government have cut back on subsidies, removed an artificial cap on the exchange rate, mounted taxes, and hiked fuel and electricity prices.

All of this as inflation soars, growth stalls, and what was once the strongest currency in the region has become the weakest, leaving the South Asian nation and its over 220 million people facing an economic crisis of exceptional proportions.

- Damning figures

Pakistan’s severe economic spiral is characterized best by the skyrocketing rate of inflation – 36.4% in April, the highest in nearly six decades.

On the foreign reserves front, the country is left with a mere $4.3 billion, just enough to cover a month’s worth of imports.

To temporarily alleviate some of the financial strain, China rolled over a $2 billion loan in late March, while Saudi Arabia extended the term of a $3 billion foreign reserve deposit it made as a loan in 2021.

On the other side is the case of Islamabad’s external debt, which has plunged by over $10 billion. That has effectively reduced its current account deficit from July 2022 to this April to $3.3 billion, significantly lower than the $13.6 billion of the corresponding 2021-22 period.

That drop is because imports were pulled down to $47 billion between last July and this April, compared to $65.5 billion during the previous corresponding period, according to Shahid Hasan Siddiqui, an economist in the financial hub of Karachi.

However, this decline in imports has dented Pakistan’s manufacturing sector, exports, and subsequently, the already struggling GDP, which is teetering towards negative growth, he explained.

“Less imports of raw materials and machinery due to a shortage of foreign reserves affected the manufacturing sector and hit our capacity for exports,” he told Anadolu.

- All bets on IMF

Other economists in Pakistan also feel the economy could tip over the edge, but reckon that the odds of a default in the near future are remote, particularly given the country’s nuclear status and the wider geopolitical situation in the aftermath of the Russia-Ukraine war.

To ease growing fears and lower the default risk, Pakistan has to somehow secure a deal with the IMF, said Khaqan Najeeb, an economist and former Finance Ministry adviser.

Along with the political tumult and external financing challenge, he cited “less than desirable economic management” as a key reason for Pakistan’s default risk.

“Pakistan’s options are limited, and without an IMF program, the default risk will stay elevated and the reserves weak,” he told Anadolu.

However, he said there are expectations that a staff-level agreement with the IMF could be sealed “in the next few days,” which would give Islamabad the funds required for external payments.

Ammar Habib Khan, a macroeconomist, shared Najeeb’s views, stressing that a deal with the IMF is “crucial” in terms of Pakistan’s ability to pay off foreign debts and prop up depleting foreign reserves.

In his view, the chances of Pakistan facing a default “immediately” are slim, but the outlook grows starkly grim for 2024.

“Pakistan can face a real challenge in terms of a default in April next year, when it has to handle $1.1 billion Eurobond payments to private investors,” he told Anadolu.

“If Islamabad doesn’t have enough reserves by that time, it will be in serious trouble.”

However, he feels that Pakistan has a lifeline in allies China and Saudi Arabia, who will continue to support Islamabad even if the IMF agreement is delayed.

- Geopolitics at play

Despite the dismal shape of the Pakistani economy, Siddiqui, the Karachi-based expert, said the country will not default unless the government consciously chooses that path.

Shedding light on the interplay between economy and geopolitics, he said Pakistan’s economic stability is essential for the interests of world powers such as the US and China.

“Economy and geopolitics are interlinked. I don’t believe that global superpowers, mainly the US and China, can afford a default by Pakistan in the current geopolitical situation,” he opined.

He said the US and its Western allies would not want to see a nuclear-armed country default, especially after the Russia-Ukraine war.

“Washington also still needs Pakistan in Afghanistan and the Middle East, whereas Beijing, which is already facing criticism from the West over CPEC (China-Pakistan Economic Corridor) loans, simply cannot afford to see Islamabad default,” Siddiqui contended.

He was referring to the $64 billion CPEC project, part of Beijing’s ambitious Belt and Road Initiative (BRI), which aims to connect China’s northwestern Xinjiang province to the Gwadar port in southern Pakistan through a network of roads, railways and pipelines to transport cargo, oil and gas.

Washington, time and again, has said the project is “not sufficiently transparent,” claiming that it will saddle Pakistan with the burden of expensive Chinese loans.

Both Islamabad and Beijing reject the criticism.

Pakistan currently owes an external debt of $125 billion, of which, nearly 25% is shared by China, according to official figures.

“If Pakistan defaults, the West will heap the blame on Chinese loans. In that case, the entire BRI could be affected,” Siddiqui asserted.

For him, Pakistan still has two alternatives to avoid default. The first is through local foreign exchange companies, which can provide financial support, and the second is the millions of overseas nationals who can contribute to the country’s financial stability.