Pakistan’s Unprecedented Economic Crisis and Calls for Restructuring Debt

Pakistan is on the brink of collapse as its import dependent economy has run out of Foreign Exchange causing food and energy shortages and the resulting economic hardship is driving political polarisation, radicalization and extremism.

Pakistan is on the brink of collapse as  its import dependent economy has run out of Foreign Exchange causing food and energy shortages and the resulting economic hardship is driving political polarisation, radicalization and extremism. Islamabad is on the hook to the IMF, the World Bank, China and others, doubling its external borrowings in the last seven years; from $65billion in 2014-15 (24 percent of GDP) to $130billion (40pc of GDP) in 2021-22.

Moody’s recently downgraded Pakistan’s rating to Caaa3 — as per the company’s rating scale, only Ca (very near default) and C (defaulted) are below the country’s current standing. The destiny of its 230 million citizens depends on foreign currency to import essentials like food, energy and fertilisers. Prime Minister Anwaarul Haq Kakar’s caretaker government has sought financial assistance of $2 billion from China for a year.

For years though, more foreign exchange has flowed out of Pakistan than in, prompting Islamabad to run persistent fiscal and current account deficits and in 2022 circumstances took a turn for the worse. with the Russia-Ukraine conflict, global commodity prices soared, placing ever greater pressure on Pakistan’s Forex reserves. Soon thereafter flooding along the Indus inundated one-third of the country devastating both subsistent farms and export crops resulting in a double whammy which further exacerbated Pakistan’s import dependence, while depriving it of export income and burdening the state with an additional 15 billion dollars repair bill which equals roughly four percent of the GDP.

By January 2023 currency reserves were sufficient only for several weeks of imports. Islamabad responded by raising tariffs on energy, insufficient Imports and leaving food and raw material shipments in the port. This clampdown stamped the payments outflow, cost production cuts and industrial decline.The textile industry, accounting for one-tenth of Pakistan’s GDP and two-fifths of employment laid off 7 million workers meanwhile factories saw gas bills raise production costs, making local products uncompetitive on global markets.

Economic privation has heightened political tensions within Pakistan and with its creditors. Islamabad’s current IMF program began in 2019 under Imran Khan’s Premiership. But not even he could square his populist credentials with the IMF’s austerity demands. Khan was eventually ousted from power in a no-confidence vote. His successor, the government of the Pakistan Democratic Movement, tried  to cover the cost of repaying its domestic debt by borrowing heavily from domestic sources, namely commercial banks. Successive governments have engaged in irresponsible borrowing, amid a hostile business environment.

Pakistan is indeed in the throes of an unprecedented economic crisis. Taxes on organised businesses in Pakistan are higher than in Western countries.Halting energy subsidies would lead to further inflation lowering consumption and inducing a recession.

Militant attacks across Pakistan killed around 1000 civilians and security forces in 2023, the highest number of fatalities the country has experienced in six years. The bulk of the attacks were in Northwestern Khyber Pakhtunkhwa and southwestern Balochistan provinces bordering Afghanistan. Preventing Pakistan’s spiral of radicalisation and instability means first solving the economic crisis, reducing military spending, pursuing economic diversification and reducing import dependency.

However the real issue is the foreign debt. Pakistan’s geopolitical importance during the Cold War and the Afghan conflict granted access to nearly endless loans and bailouts from the IMF and other Western institutions. Yet the sums involved were beyond Pakistan’s repayment capacity and most importantly they were denominated in foreign

currency. Of the total external public debt of $99billion, multilateral debt — owed to international financial institutions — accounted for 42pc. The share of bilateral debt — mainly country-to-country loans — is approximately 38pc and the largest share within this category is of China ($23billion).

The financial condition has become so bad that the monetary policy has lost its ability to control inflation, which is soaring. Service on Pakistan’s dollar denominated obligations is 26 billion dollars for 2023, which drains the foreign exchange that is needed for essential imports. The cost of servicing domestic debt for FY24 is projected at Pakistani Rupees 6.43 trillion or roughly 70 percent of tax revenue.Though the country may avoid the fault in the short run, in the long term its growing $128 billion stock of external debt is unsustainable.

Harsh austerity demands may also prove self-defeating should they push Pakistani politics further into crisis. A viable solution might be for the creditors to restructure the residual debt, postpone immediate interest payments and ensure new capital flows. Otherwise the massive external debt will drag Pakistan  down, foreclosing any chance of recovery. Data compiled from World Bank, UNICEF, Economic Survey, International Diabetes Federation, UNAID, and SBP, indicates that with $128 billion Pakistan has one of the highest external debts, placing it among the 73 states eligible for the World Bank’s Debt Service Suspension Initiative.

Influential policy makers in Pakistan may be seriously suggesting it. Speaking to the Dawn former Federal Board of Revenue (FBR) chairman Shabbar Zaidi, opined that Sri Lanka was better off after default and that “default is a taboo, but that is not the case.” However the fact is that even though the long fuel lines have disappeared, two out of five households in Sri Lanka are spending 75 percent of their household income on just food purchases. Colombo underwent a 100 basis points increase in the policy rate, to avail a $2.9bn bailout package. So if Pakistan were to default tomorrow the inflation rate and scarcity would increase.

Former  governor of the State Bank of Pakistan (SBP) Dr Reza Baqir believes that debt restructuring for Pakistan will be “very difficult as a process” given that most of its foreign loans are “because of the type of debt that dominates on the balance sheet of Pakistan.” With regard to restructuring he says that “for multilaterals, that’s almost impossible. For bilaterals, even in its heyday, (the) Paris Club was loath to give debt reductions, and continued to give rescheduling even if the insolvency of the country was staring them in the face.”

While Pakistan has not officially declared its inability to pay off its loans, it is borrowing or rolling over debt to continue to stay afloat. Since 2014 the proportion owed to private creditors including commercial Banks and bondholders has risen from 19, to 30 percent. These entities will likely frustrate any debt resolution effort that does not pay them out in full.

 Debt restructuring negotiations are not without subterfuge especially since Pakistan’s external debt structure carries geopolitical implications. West-dominated multilateral creditors like the IMF, the World Bank and also the Asian Development Bank, hold around one-third of Pakistan’s external debt. But they maintain that the write down would hurt their credit ratings and ability to discharge functions. The United Nations Development Programme’s (UNDP) Dec 2023 publication ‘Development Advocate Pakistan’ says that any new government in Pakistan must have a plan to tackle the debt challenge. As per the report the country’s ‘options to resolve the ongoing debt crisis are very limited, adding that the country is likely to continue relying on short-term measures of rollovers, along with additional external borrowing to ease debt pressure.’

Beijing is Islamabad’s largest bilateral creditor, holding one-fifth of its external debt. It is also Pakistan’s best hope for debt forgiveness.It has been providing short term relief to Islamabad by rolling over the debt, but the de facto maturities of rolled-over Chinese rescue loans run longer, ultimately making Pakistan more dependent on Beijing.

There is also a qualitative difference since the Chinese debt pertains to tangible infrastructure projects like the China-Pakistan Economic Corridor (CPEC) which connects Xinjiang with Gwadar port through Pakistan, reducing trade dependence on the Malacca Strait.

Having sunk $65 billion into such projects, a stable Pakistan is crucial to Chinese interests and given a rise in attacks targeting Chinese nationals and the threat of jihadism spilling into Xinjiang, Beijing is unlikely to force Islamabad to repay its loans. Doing so would harm the Chinese position on the grand geopolitical chessboard. The question is will China make unilateral concessions for Pakistan?

Vaishali Basu Sharma
Vaishali Basu Sharma
Vaishali Basu Sharma is an analyst of strategic and economic affairs. She has worked as a consultant with India’s National Security Council Secretariat (NSCS) for nearly a decade. She is presently associated with New Delhi based think tank Policy Perspectives Foundation.