ECONOMIC CRISIS AND WAY FORWARD april 2019

Pakistan’s economic woes – dwindling foreign exchange reserves, low exports,

high inflation, growing fiscal deficit, and current account deficit – are nothing new,
and once again, the country finds itself knocking on the doors of the International
Monetary Fund (IMF) for what will be its 22nd loan. While the exact amount of
this package has not been determined, Pakistan already owes the IMF billions from
previous programs. Indeed, 30.7 percent of Pakistan’s government expenditure
is earmarked for debt servicing, which cannot be supported by its decreasing
revenues. Already on the Financial Action Task Force’s (FATF) grey list, and with
the current Pakistan Tehreek-e-Insaaf (PTI) government enjoying internal
institutional consensus on the national agenda, Pakistan must focus its attention on
resolving its economic woes before it finds itself on the shores of bankruptcy.

Current State of the Economy

In 2019, Pakistan finds itself facing a dire macroeconomic crisis. It is spending

more on imports than it receives on exports, with its current account deficit having
risen from $2.7 billion in 2015 to $18.2 billion in 2018. The major driver of this
rising current account deficit is an expanding trade deficit, which is mostly due
to the rising imports under new China-Pakistan Economic Corridor (CPEC)
projects and low exports in general. The previous government focused more
on import-led growth strategy to finance large scale projects under CPEC. By the
end of June 2018, the gross public debt of Pakistan reached USD $179.8 billion,
showing an increase of $25.2 billion within a year. More than half of this increase
in gross public debt was due to an increase in public external debt, which grew by
30.1 percent. In 2018, the depreciation of the Pakistani rupee against the U.S.
dollar alone was responsible for an excessive USD $7.9 billion increase in public
external debt.

Despite the massive depreciation in the rupee, Pakistani exports

have remained almost the same. Meanwhile, the government’s external debt has
also increased from $64.1 billion in June 2018 to $65.8 billion in January 2019.
The inflation rate is now touching 9.4 percent, which is a record level high over the
last five years mostly due to rupee depreciation and rising energy prices. In
addition, increased defense spending and its ongoing fight against extremism only
further burden the economy. Along with a depreciating rupee that has made
imports costlier, low foreign investment due to Pakistan’s security and political
challenges has also severely hit its foreign exchange reserves.
Despite rising deficits, Pakistan’s tax revenue was only 13 percent of its GDP in
2018. During the current fiscal year, the country has seen a decline in its revenues
while expenditures have increased, resulting in a half-year fiscal deficit of 2.7
percent of GDP, the highest since 2010-11. According to the State Bank of
Pakistan, the sharp decline in revenue can be attributed to a fall in development
spending, reductions in income and corporate taxes, and taxes on petroleum
products, as announced by the previous Pakistan Muslim League-Nawaz (PML-N)
government.

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Similarly, the previous government failed to make any significant progress in

enhancing exports: in fact, Pakistan’s total exports fell in real terms during the
PML-N’s tenure. In its recent report “Pakistan @100: Shaping the Future,” the
World Bank held weak governance responsible for the fiscal deficit.
Pakistan’s poorly regulated financial system facilitates tax evasion, which
contributes significantly to the growth of the fiscal deficit. Having inherited this
economic crisis from the previous government, the PTI government, led by Prime
Minister Imran Khan, has an enormous task ahead: steer Pakistan’s struggling
economy out of a macroeconomic crisis by fostering economic development.

With its domestic industry in ruins, Pakistan has not been able to rely on consistent
foreign investment for more than stopgap measures. It did recently receive $2
billion from the United Arab Emirates (UAE) through the Abu Dhabi Fund for
Development (ADFD), which provides concessionary development loans. This
inflow has increased Pakistan’s foreign reserves from $14.956 billion at the start of
March 2019 to $17.398 billion. In February, the Crown Prince of Saudi Arabia,
Mohammad bin Salman, signed seven Memorandums of Understanding (MoUs)
with Pakistan, pledging up to $21 billion worth of investment over the next six
years. However, relying only on foreign aid and friendly countries for loans is not
enough. If Pakistan is to tackle its current account deficit in the long run, the
government must take substantial steps to improve the macroeconomic conditions
of the country and modernize its industrial sector to become more competitive in
international markets.

The Way Forward: Steps for the Pakistan Government

To make a significant impact on the current account deficit, Pakistan needs to

ensure an investment-friendly environment that attracts more foreign direct
investment (FDI), instead of relying so heavily on foreign aid. According to the
World Bank’s Ease of Doing Business report, Pakistan ranks 136th out of 190
economies. To improve this ranking and draw more investment, Pakistan should
ease customs laws and regulations, improve the security of the country, and
rebrand and boost its international image as a desirable destination for tourism and
industry alike – a goal the current government is set to pursue as it eases its visa
policies, including its introduction of e-visas. It should also encourage domestic
investment through more flexible tax policies, particularly targeting small and
medium-sized enterprises (SMEs). Such measures would reposition Pakistan on
the international stage as stable, competitive ground for foreign investment.

Pakistan also needs to focus on building its domestic industry to expand its export
portfolio and enhance its competitiveness in the international markets. In 2018,
Pakistan ranked 107th out of 140 on the Global Competitiveness Index (GCI),
which measures the performance of countries in indicators such as infrastructure,
ICT adoption, macroeconomic stability, labor market, skills, financial stability,
innovation capacity, etc. The low ranking signifies that the Pakistani government
needs to take measures to stimulate economic growth and provide favorable
business environment. The country’s ongoing energy crisis, which has caused
significant losses in industry, has led factory owners to increasingly relocate to
countries such as Bangladesh. Moreover, since its exports currently lose out to
low-priced, good-quality products from countries like China and Bangladesh,
Pakistan needs to modernize its industrial sector by establishing new plants and
equipment to enhance global integration. It can do this by investing in research and
development (R&D) to encourage product innovation and enhance labor
productivity.

On top of these issues is the larger question of Pakistan’s failure to expand its
export portfolio beyond a few low value-added products, such as textiles, rice,
surgical goods, carpets, sports goods, and leather items, which is one of the largest
factors behind its balance of payments deficit. Broadening the country’s export
portfolio and exploring new export destinations such as Eastern European and
Central Asian countries could revitalize foreign exchange earnings. As a security-
oriented state, Pakistan’s priority has never been the economy, but it now needs to
focus more on geoeconomics over geostrategy.

Currently, Pakistan is not taxing its agriculture sector and large businesses are
often given big tax breaks. Hence, Pakistan needs to broaden its tax base – by
taxing the agricultural produce of landlords with big land holdings and stop giving
tax amnesties to big businesses – instead of overburdening current taxpayers,
improve fiscal transparency, and strengthen tax collection coordination at the
national and provincial levels to ensure that revenue targets are met. These steps
would go a long way to addressing the myriad financial and deficit issues
stemming from the country’s weak governance.

Conclusion

The coming months are going to be tough for the current government as the rupee
is expected to depreciate further, causing inflation to rise. Pakistan’s economic
crisis cannot be resolved overnight. Support from the IMF and friendly countries
like Saudi Arabia, China, and the UAE will only provide some breathing room in
the short term to its shattered economy. Promoting manufacturing by creating a
more investment-friendly environment, broadening its tax base, and encouraging
innovation and modernization in export-led industries are just some of the most
urgent measures the government can take to address the growing fiscal and current
account deficit. Pakistan must take advantage of this moment of hard-won
reprieve by building a truly stable and sustainable economy before it once again
finds itself digging its own economic grave – and that of its people.