Impending economic crisis in Pakistan

As Pakistan’s economy struggles under the combined burden of external and domestic debt, spiraling inflation, sharply depreciating Rupee, widening trade deficit and other macro and micro-economic parameters, Islamabad is trying to address its problem of economic revival and debt servicing through external assistance. When the economy is burdened by debt and foreign exchange reserves are depleting, one of the solutions for the problem lies in soliciting foreign investment, but that may not be an easy option for Pakistan.

Ironically, on one hand Islamabad has sought a bailout from the International Monetary Fund (IMF) through its Extended Fund Facility (EFF) which has stringent conditions; on the other hand, it expects China to be a savior.  The government is struggling between the Western driven efforts through the IMF to institute some discipline and austerity (with obvious adverse political consequences), and the Chinese market-averse investment strategy with its insistence on sovereign guarantees and exclusivity to ensure the profitability of its State owned enterprises.

Pak PM had earlier announced a target of enhancing the inflow of Foreign Direct Investment (FDI) to the country from USD 2.56 billion in FY 2020 to USD 7.4 billion by FY 2023. But present indications reveal that Pakistan is far from realizing this goal given the economic problems facing the country and its decline in credit rating to ‘B’, the minimum of investible grade. It is doubtful if other nations will come to Pak’s rescue, but Islamabad does expect assistance from China though Beijing may also have issues.

Recent trends for FDI in Pakistan are discouraging. FDI had declined to USD 1.4 billion during July-March FY 2020-21, compared to USD 2.2 billion in the same period of previous year. Business environment in Pakistan is not too encouraging. Foreign investors in the country face many problems like, inadequate connectivity, shortage of gas, especially during the winters, erratic power supply, poor internal security, absence of single window for clearances and cumbersome administrative procedures, etc. Gwadar Free Zone (GFZ) is also not an exception in spite of announcement of investor friendly measures by the Pak government.

The response from China to invest in GFZ-I has been rather sluggish too. Despite Zhang Baozhong, the Chairman of China Overseas Ports Holding Company, claims of over 43 Chinese companies being interested to invest in the zone and 200 more firms having registered for the same, only 5 Chinese companies were operational in the GFZ by the end of 2021. This was the response despite special incentives offered to Chinese investors like 99-year lease, duty-free imports & exports, etc. In fact, Chinese net FDI has declined by 24.3% during July-March FY 2020-21 compared with the same period of previous year. Some experts note that though Pak has opened third country investments, many countries have reservations about Chinese dominance in GFZ.  It was viewed that the GFZ, while lacking the investments/projects to be a viable industrial hub, still serves Chinese strategic interests as a potential logistics hub for essential supplies and PLA Navy deployments in the region. Incidentally, Pak Board of Investment (BoI) had apparently flagged that bulk of Chinese investment in Pakistan is through the state-owned enterprises and in energy sector.  BoI has underlined the need to encourage business-to-business ties to incentivize Chinese companies to relocate manufacturing to Pakistan and to achieve Pakistan’s goal of labour intensive & export-oriented industrialization.

Meanwhile, meeting the IMF conditionality is a prerequisite for financial assistance, but it would entail tough and politically unpopular decisions, especially at the time of Covid-19, when economic activities have already declined. Pakistan has requested the IMF to delay the board meeting (January 12) for the sixth review of recommendations. Islamabad introduced (December 30, 2021) Supplementary Finance Bill 2021 (mini budget), proposing amendments in income tax, sales tax and federal laws to realize Pakistani Rupee (PKR) 375 billion tax measures including withdrawal of tax exemptions to meet IMF conditionality. The bill, however, met fierce resistance from the opposition. So far, Pakistan has failed with regard to IMF’s recommended fiscal tightening measures for the release of USD 1 billion under the USD 6 billion three-year Extended Fund Facility (EFF) program.

Chinese companies working in China-Pakistan Economic Corridor (CPEC) projects, especially power projects, are also feeling the heat of the ‘mini budget’ as it proposed withdrawal of sales tax and exemptions on import of capital equipment & spares. This would reduce the profitability of Chinese companies. China Gezhouba Group Co. (CGGC) which is undertaking 700 MW Azad Pattan Hydropower Project on Jhelum River had already threatened that the IMF conditionality would adversely affect the project.

The economic crisis in the country appears to be worsening. Pak economic recovery is constrained with not only twin deficits – high fiscal deficit and current account deficit, but also due to depreciation of the Pakistan Rupee (PKR)  against the dollar (about 30% since 2018) and a high a rate of inflation (12.3% in December 2021). The fast depreciating PKR and high inflation in 2021 added to Pak’s woes of debt burden. The problem is further compounded due to falling foreign exchange reserves while its debt servicing requirements in the immediate future have increased. Pakistan’s external sector vulnerabilities have also multiplied and touched alarming levels. The country’s external debt servicing obligation during December 2021–June 2022 period has increased to USD 8.64 billion, about one third of its foreign exchange reserves which stood at USD 24 billion in December 2021.  Pakistan took USD 15.32 billion foreign loan in FY 202-21 as against USD 10.45 in FY 2019-20. Pakistan’s cumulative external debt has almost doubled in the last three years from USD 35 billion to about USD 85.6 billion.

The World Bank estimates that the Pak economy would recover with a very slow GDP growth rate of 3.5% in the FY 2020-21 from a negative growth of -0.5% in the previous year (FY 2020). An IMF working paper on Pakistan’s Sustainable Development Goals (April 2021) noted that Pakistan’s current performance in education, health, electricity and water and sanitation – as measured by the Sustainable Development Goals (SDG) indices of each sector – is below the median for Emerging Market and Developing Economies (EMDEs). Pakistan’s performance in education and water and sanitation is also below the median for countries with GDP per capita below USD 3,000. The IMF concluded that making substantial progress in critical SDG will require additional annual spending about 16% of GDP by 2030. It remains to be seen how the Pak political leadership would steer the country out of the impending crisis.