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Pakistan’s state of denial

There seem to be two conflicting views about the state of Pakistan’s economy.

The first shared by most independent economists and analysts is that the worsening fiscal and balance of payments deficits warrant urgent corrective action otherwise the country will head inescapably into an economic crisis.

The second view held mainly by the government’s economic managers is that there is no near term risk to the economy or looming crisis and they can continue with business as usual. This helps to explain why in its last days in power, the government has gone on a pre-election spending binge, which will leave public finances in complete shambles.

In recent public statements the governor of the central bank and finance minister have both chosen to downplay the threat posed to financial stability by the country’s critical balance of payments situation for which the evidence is overwhelming. Both insist Pakistan has enough foreign exchange reserves to meet its external debt obligations so there is little reason to worry. It seems to escape both of them that a crisis doesn’t wait to erupt when foreign exchange reserves fall to zero. It can happen when the reserve level dips so low as to spark panic in the market and send confidence plummeting. This is not a hypothetical scenario. It unfolded not long ago in the 2008-09 balance of payments crisis. In fact, at several points in the 1990s Pakistan was unable to meet its external financing requirements and repeatedly sought IMF help to avert external debt default.

The facts are clear about the present precarious situation. Last week reserves held by the State Bank fell to $ 7.8 billion. This offers no assurance that the country can avoid a balance of payments crisis when capital inflows have dried up, foreign direct investment has plunged to the lowest ever level and debt payments loom.

In the next fiscal year $6.2 billion in debt service payments will be due to the IMF and other creditors by which time reserves would have dipped below $6 billion and with the trade gap also needing to be financed. Confidence could vanish quite quickly when the market perceives that the country’s financial requirements far exceed its foreign exchange resources. No one can accurately predict when such an inflection point could be reached. But no responsible government would want to wait for that to first happen and then respond to a runaway crisis.

To compound an explosive budgetary situation, the government has also gone on a no-holds-barred spending spree in its last days in power. This is reflected in a number of fiscally irresponsible decisions taken in recent weeks, mostly by the cabinet’s Economic Coordination Committee, which met four times in just over a fortnight — unprecedented in Pakistan’s economic history.

The decisions are too numerous to list. But the more egregious ones include:

• Subsidy for sugar exports, which will cost the exchequer at least Rs. 3 billion a year — and benefit a politically powerful lobby.
• Reduction of electricity charges for agricultural tube wells. This transparent bid to win rural votes will drain budgetary resources of Rs. 16 to 20 billion a year.
• Rs. 10 billion increase in the Public Sector Development Plan, which will be channeled into various politically motivated schemes to win electoral support.
• Rs. 48.5 billion doled out last month to the unreformed power sector when the average monthly cost of subsidies to the exchequer is Rs. 20 billion. This advance payment has been made without explanation at a time when recoveries have substantially declined.
• Rs. 100 billion bailout for the national airline with no credible restructuring of the ailing company in place.
• Another substantial pay rise for government employees, which will cost the exchequer Rs. 7-8 billion a year. This comes on top of previous increases in the past five years, cumulatively amounting to 120 per cent.

This fiscal profligacy comes at a time when government revenues have plummeted.

If the resultant larger fiscal deficit continues to be financed by more borrowing the consequences are inescapable — higher inflation and addition to an unsustainable domestic debt. This is already part of the explosive economic legacy being bequeathed to the next government by the PPP-led coalition — contrary to the government’s ‘all is well’ claims. With the fiscal problem feeding into the increasingly shaky external account, the question is not if but when the country will face a foreign exchange crisis — unless urgent action is taken to avert this.

Dr Maleeha Lodhi served as Pakistan’s ambassador to the US and United Kingdom