Part I: Debt and Consequence
Introduction
The vast interconnection of a fascinating global economy has laid the foundation for international money lending, borrowing, and debt, the sine qua non of public investments. Foreign debt, or simply a country’s gross external debt, is defined as the amount of money owed by a country’s residents to non-residents. This money is owed to governments, individuals, or international organisations like the World Bank or the International Monetary Fund (IMF). These debts-on-steroids are predominantly manageable by countries because they are net creditors, which means they have lent more money to other countries than how much they owe. This, unfortunately, is not the case with the subject of this study, the Islamic Republic of Pakistan. A country that has, in the last half-decade or so, found itself in an unseemingly backbreaking economic crisis.
The ongoing meltdown in Pakistan is a distasteful cherry on top of a rocky economic past. With a deteriorating economy earmarked by dwindling foreign exchange reserves with the currency spiralling downwards at more than PKR 260 to the US Dollar and soaring fuel prices, polemic decision-making, worsening political turmoil, and surging terrorism, Pakistan seems to have it all. The country is walking a decaying and shaky tightrope that raises humanitarian, military, and geopolitical concerns everywhere.
To add to the problem, as of June 2023[1], Pakistan’s total debt and liabilities (foreign debt) stands close to USD 120 billion, which is a staggering 90% of the country’s gross domestic product from FY22. This puts Pakistan in quite a precarious situation, considering their ceaseless enthusiasm for funding defence programs, whilst neglecting infrastructural, human, and geopolitical security. The country has also allocated a startling US$ 6.26 billion towards a 16% increase to its defence budget, despite being at an impasse with the IMF[2].
Let’s dig deeper.
What does this debt consist of?
Pakistan’s external debt primarily consists of five major classifications: Paris Club debt, multilateral debt, commercial and private debt, Chinese debt, and Saudi Arabian debt.
Pakistan owes over $8 billion in debt to the Paris Club, according to official ministry documents. The Paris Club is a group of international creditors that assess the fiscal situation of debtor countries in the world and appropriately make decisions to provide debt treatments in the form of debt rescheduling; for a defined period with set protocols and agreements in place[3]. This debt, while a long-term one with a soft interest rate, poses a significant percentage of the overall foreign debt composition.
Multilateral debt[4] is the portion of external debt owed to multilateral financial bodies or institutions, like the World Bank or the International Monetary Fund (IMF). Around 30% of Pakistan’s debt is composed of multilateral debt owed to the World Bank ($18B), the Asian Development Bank ($15B), and the IMF ($5B, a number recently reduced due to the announcement of a Standby Agreement[5]) and a smaller portion to the Islamic Development Bank and the Asian Infrastructure Investment Bank. Interestingly, multilateral debt rarely poses a threat to a debt-ridden country due to softer interest rates and regular concessions.
Earlier this year, Pakistan seemingly received the short end of the stick in January 2023, with the World Bank delaying the approval of two loans worth over $1 billion due to concerns about fiscal prudence and returns. This created cause for concern in Pakistan, which now had a half-billion hole in its annual financing plan. Luckily, with the RISE-II[6] and PACE-II[7] loans in the recent pipeline, the World Bank plans to nurse Pakistan’s monetary wounds, one step at a time.
Pakistan’s primary challenge comes with their unsustainable private and commercial loans amounting to nearly $8 billion[8], consisting mainly of private bonds (Eurobonds), with exorbitant interest rates ranging from 5-9% for periods from 5 to 30 years. This number will grow with every fiscal year. Unsurprisingly, most of these debts are attributed to Chinese lenders, with all of them coming at gruesome interest rates and short-term demands; characteristics that do not bode well for the debt condition today.
The Chinese Angle
China time and time again, has swooped in to save Pakistan’s emergency repayment requirements with rollovers, emergency loans, infrastructural initiatives, and other FDIs. Over the next three years, Pakistan is required to pay China and other creditors close to $77 billion, a steep goal for a $350 million economy. A few weeks back, China agreed to reschedule more than $2 billion debt from a larger $6.3B debt, for two years, providing major relief to the cash-strapped country and assisting in rebuilding external liquidity[9].
This concession provides some relief, but only for a limited period. The following fiscal year will be more difficult since debt servicing will increase to about $25 billion. The short-term debt repayments include $2 billion in Chinese SAFE (State Administration of Foreign Exchange) deposits remaining from the rollover, which the Pakistani government expects to roll over each year. Pakistan will also have to return $1.1 billion in long-term commercial loans to Chinese institutions[10].
Typical of Chinese investments, this complicated financial relationship with Pakistan is as layered as it gets. Peeling away these layers, we recall the China-Pakistan Economic Corridor (CPEC)[11], Beijing’s massive Belt and Road initiative investment plan to boost trade and economic ties with Pakistan. CPEC displayed China’s aggressive efforts to build trillions by investing in Asia - more than $35 billion pledged for energy projects and another $10 billion for transportation. Until a few days back, the Chinese government was steadfast in its statement of disappointment in the lack of progress with the CPEC due to Pakistan’s economic crisis and the immense disadvantage it would pose to China’s plan for economic assistance and growth with Pakistan. With the announcement of the generous rollover, China has made it clear that Pakistan’s economic stability is of immense importance to its interests. On July 31st, 2023, The Prime Minister of Pakistan signed six agreements with the Chinese government[12] to expand the progress and protocol of the CPEC, thus cementing and repairing recent apprehensions of the latter.
What remains hidden under these veils is that for the people of Pakistan, the CPEC project has brought about nothing but suffering on a very important and known front — energy. Pakistan’s infamous power shortages have been a result of exorbitant energy costs and neglect of electrical power plants, transmission lines and services, and domestic sources. A misplaced focus on their saviour’s cunning infrastructural investments ended up creating power outages that last nearly half a day in major cities and nearly a day in other places; inadvertently disrupting the flow of all industrial, medical, social, academic, and corporate activity, and hence adding onto the growing economic decline, little by little.
All-Weather Brother: Saudi Arabia
Saudi Arabia and Pakistan have shared a connection far beyond the aspect of religion for decades on end. Saudi, unlike China, has never failed to provide reprieve to their ailing ally. In 2022, after Shehbaz Sharif met with Crown Prince Mohammed Bin Salman, Saudi Arabia provided a generous bailout of close to $8 billion[13], consisting of increased oil financing, debt rollovers, and other long-term deposits. In a room full of hungry moneylenders, Saudi seems to remain a true friend. But for how long?
Apart from China, Pakistan owes a significant amount of money to Saudi Arabia. As an instalment of July 2023, Pakistan had to pay around US$ 195 Million to Saudi Arabia, not counting the various long-term multilateral debt that is owed to the Middle Eastern country. Pakistan over the last decade failed to return most of its requirements, but Saudi has seemingly not cared for these semi-defaults. Right before the recent IMF bailout package issued to Pakistan as a last-breath-for-air, Saudi confirmed a decision to loan another $2 billion to Pakistan to assist in their approval for the IMF deal.
Continual defaults and poor returns will not bode well for trade and currency between the two countries. While Saudi’s generosity seems to be durable, it is not unconditional. In return, Pakistan provides Saudi with an unending supply of a cheap workforce, an oil clientele, and other markets for investments. It is no hidden fact that Saudi Arabia has built this relationship since the 70s to propagate its anti-Iran agenda, and secure geopolitical strength with Pakistan. In April 2015, soon after receiving a $1.5 billion Saudi loan, Pakistan’s parliament stayed greatly neutral diplomatically for the Saudi intervention in Yemen, which was backed by Tehran according to officials in Riyadh. How much tighter will this hold on Pakistan get?
Part II: Err and Repent
The IMF
Pakistan and the IMF have a pretty interesting history. For 65 years, Pakistan has brazenly requested bailouts from the IMF for their loans an outrageous 22 times [14] - with the most recent one having been a few months back. The IMF has brutally turned down every single one of these requests due to Pakistan’s failure in their matching of all the requirements for a bailout in the IMF rulebook. Furthermore, the country’s stubborn expenditure on defence, politics, and other questionable segments, with an increased neglect towards cerebral investments, has strongly dissuaded the IMF and its creditors from extending financial assistance to Pakistan.
In February 2023, The government of Pakistan came up with a circular debt management plan and attempted to negotiate with the IMF for a release of $1.1 Billion from a $6.5 billion bailout contracted up to 2029. This plan was unfortunately denied by the IMF which went so far as to call the plan ‘unrealistic’ and that it had been made based on “certain wrong assumptions”. The IMF pressured the country to increase its electricity tariffs, amidst attempts to fix past mistakes of poor subsidy management in the electrical energy sector. The government responded by increasing taxes and fuel prices all over the country.
Recently, however, Pakistan received an unprecedented, generous bailout of around $3 Billion as part of a strict Standby Arrangement (SBA) [15] with the IMF, accredited to a Chinese rollover prior and a magnanimous loan of $2B by the Saudis. This may seem like a blessing to the people of Pakistan, but this SBA is a result of the failure of the IMF’s Extended Fund Facility (EFF)[16] with Pakistan. The EFF program aimed to uplift the Pakistani economy and provide appropriate funds for development. In 2019, a statement from the IMF[17] spoke of progress albeit with ‘many risks’ of poor ownership and reform management. These wounds festered, a tragic crisis in the form of a flood, and bland performance reviews year-on-year led to the failure of the EFF, which had made Pakistan more desperate than ever.
This Standby Agreement support program will provide detailed policies to address internal and external imbalances, create fiscal discipline, and a stronger shock absorber to external repayment pressures. The Fund will initially provide Pakistan with close to US$ 1.2 Billion to work on social and economic improvements. Further, this fund will strengthen the Pakistani battle for disinflation, to escalate progress on social reforms, fiscal structure, and energy sector expenditure. This SBA stands in the way of Pakistan defaulting on its debts, but it is far from a long-term solution. The Pakistani government expressed their great plight multiple times, having no choice but to match the bailout conditions that went ‘beyond imagination’, according to PM Shehbaz Sharif[18]. Apart from repaying debt amounts to different countries, Pakistan now has to repay the IMF to clear outstanding loans of USD 189.67 million including a principal amount of US$ 165 Million[19].
The Currency of Trade
In February 2022, the world watched as Pakistan displayed great potential in growing into a strong currency, with an improvement of close to 3.5%. This unfortunately couldn’t have gone worse, with the Pakistani Rupee falling 9.6% against the dollar a year later, in February 2023, closing at around PKR 255 per USD – the biggest drop in over 20 years. In March, the rupee hit a record low of 284 per US Dollar in local trading[19]. The currency continued to decline amidst intense tension with the IMF’s stalled program, with all these signs pointed towards a desperate request for help which would eventually lead to assistance provided in the form of an SBA later in July.
While the currency received some breathing space with a visit to the 270s to the Dollar, this was only because of the IMF SBA deal and the Saudi loan. The PKR is predicted to close at around 295 on the Dollar by the end of the year.
Some common effects of sovereign default are considerable [20]. One, interest rate rise for corporates from the same country rises because the national borrowing rate increases, thus disrupting trade and commerce with banks becoming sceptical about lending money. Two, the exchange rate plummets as seen in the case of FY23 for Pakistan. Third, a major section of concern for Pakistan involves the imposition of trade embargoes. These embargoes obstruct the influx and outflow of key commodities required by a country, suffocating its economy. Further, another social cause for worry arises from rising unemployment, as the country will slowly be unable to pay more and more workers’ salaries, which results in the GDP coming down, accentuating the severity of this crisis.
Political Turmoil
Ongoing political turbulence could not have come around at a worse time. With the arrest of former PM Imran Khan, an ongoing back-and-forth between Imran Khan and current PM Shehbaz Sharif has plagued the crisis effort with disruptions since the ousting of Imran Khan as the Prime Minister through a motion of no-confidence. Demands for an election, public unrest, and the arrest of Imran Khan in May led to more chaos caused by his supporters in the PTI (Pakistan Tehreek-e-Insaf). With the current government blaming the previous and vice-versa for the ongoing economic meltdown, it is obvious that a lack of economic wisdom in both governments led to poor subsidy management, illogical budget allocations, and unnecessary political expenditure.
Conventionally, one would deduce that a crisis in Pakistan is good news for the Indian population and the government. With the Pakistani army probably occupied trying to nullify the ongoing political unrest and finances redirected to fixing social order, surging terrorism and violent non-state actors pose a real and dangerous threat. Smaller radical organisations take undue advantage of internal crises and redirect public and military attention to enact their corrupt agendas. New Delhi worries that the current state of the Pakistani economy may lead to a loss of ground rationality keeping several ceasefires in place at the Line of Control, especially noting the influence the military holds over internal politics and decision-making.
Conclusion
Even though consumption remains a growth driver, Pakistan has failed to strengthen productivity-enhancing investment and exports, which would have laid the groundwork for significant economic growth. Unfortunately, the leadership’s misguided priorities and political uncertainty have gotten in the way. Inaction will lead to chaos and a breakdown of social lifestyle and order, creating nothing short of a humanitarian crisis.
Pakistan’s economic governance needs to be decoupled from its political leadership at this juncture and should imbibe better market intelligence and fiscal transparency, especially in governmental procurement from external markets and imports. With the recent IMF deal, the Chinese rollover, and money coming in from Saudi and the World Bank, Pakistan must take logical and calculated steps to fix its broken castle.
In closing, Pakistan stands in a position today that calls for fiscal prudence, faultless decision-making, and an increased effort to improve the socioeconomic situation.
Article by,
Yash Mutnalkar,
Head of Finance,
PES MUN Society (RR Campus)
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