FEBRUARY 28, 2023

Pakistan’s Twin Crises

The Dangerous Convergence of a Collapsing
Economy and Surging Terrorism
A S FA N D YA R M I R

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twin-crises
 Pakistan’s Twin Crises

Pakistan’s Twin Crises

The Dangerous Convergence of a Collapsing
Economy and Surging Terrorism
A S FA N D YA R M I R

P
akistan is beset by twin crises. An economic meltdown, underway
for several years, has metastasized into a full-blown balance of
payments emergency. The nuclear-armed country is running out of
dollars to pay for essential imports, such as oil, and help from the IMF
remains stalled because Pakistan’s political leadership is reluctant to enact
a range of essential reforms. Concurrently, an anti-Pakistan terrorist
group, the Tehreek-e-Taliban Pakistan (TTP), has resurged, fueled by the
return to power of the Taliban in Afghanistan—enabled, ironically, by
Pakistan’s own policy of supporting the Taliban over the last two decades.
In January 2023, a suicide bomber killed over 100 people in a mosque
frequented by police officers in the city of Peshawar, marking the single
deadliest terrorist attack on security forces.
These crises are primed to get worse. And although they are developing
separately for now, they will feed off one another if left unchecked.
Pakistan’s current approach of stalling on the IMF’s requirements and
implementing fiscal half-measures put it on track for economic failure,
which will stoke public discontent; its policy of downplaying the Taliban’s
support for the TTP will also lead to terror attacks. Pakistan’s Chinese

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allies, who have major investments in Pakistan as part of the Belt and
Road Initiative, may step in with last-minute economic support as the
crisis peaks, but their terms for such an intervention will further erode
Pakistan’s sovereignty without alleviating either of the economic or
terrorism crises. The United States should not help Pakistan get reprieve
from IMF-mandated reforms but steer it toward a debt-restructuring
process. It should also push Pakistan to limit economic ties with the
Taliban and, at the same time, expose the Taliban’s support for terror
groups, such as the TTP. That alone will not solve the dysfunction ailing
Pakistan, but it will provide the basis for an economic recovery and
containment of the terrorist threat—and advance U.S. interests.
NO PAIN, NO GAIN

The ongoing economic meltdown has its immediate origins in a stop-start

IMF program, which Pakistan begrudgingly entered under Prime
Minister Imran Khan in 2019. After initially shepherding the program
responsibly, Khan’s government leaned into populist measures—offering
large subsidies on oil, taking on additional debt, and refusing to raise taxes
—which derailed the process. After the ouster of Khan in April 2022, the
new government revived the IMF scheme by partially withdrawing fuel
and electricity subsidies.
But as the pain of those adjustments set in, Prime Minister Shehbaz
Sharif balked at implementing more IMF-required austerity measures.
Sharif—and his brother Nawaz Sharif, who has been prime minister three
times—became paralyzed by the political fallout of the IMF’s plans,
which has only helped their chief political adversary, Khan. Indeed, the
ousted prime minister, who has been clamoring that the military along
with the United States engineered his removal, capitalized on soaring
inflation and the economic downturn to agitate and doubled down on his
demand for early elections. In response, Sharif has pleaded to partners in
China, the United States, and the Middle East for help to evade IMF-
mandated reforms. China, which holds 30 percent of Pakistan’s $100
billion external debt, has extended some help, including a $700 million
loan for refinancing. But Beijing has not been obliging in the way

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Islamabad had hoped—for example, by providing accelerated loan

rollovers and additional financing large enough to offset Pakistan’s debt
burden. In the current fiscal year alone, Pakistan owes nearly $9 billon out
of $15 billion in debt servicing to China. Because the government is
dragging its feet on reforms and the IMF is skeptical of its pledges to
change in the future, Pakistan has missed out on a crucial IMF tranche to
replenish its dwindling foreign exchange reserves, which has aggravated
the crisis.
Khan’s and Sharif ’s recent economic mismanagement and evasion of
reform are part of a long-standing pattern. For years, Pakistani leaders
have underinvested in human capital. The military, which wields
tremendous power, has warped economic policy by prioritizing rivalry
with India and taking significant chunks of the country’s narrow resource
base. Elites have rigged much of the economy, which has disincentivized
foreign direct investment and innovation. Both military and civilian elites
have avoided reform while arguing that Pakistan is too big to fail as they
seek assistance—in aid from the United States and from backers in the
Middle East, as well as expensive debt-laden projects from China. All of
this has contributed to low productivity, poor tax collection, and debt that
is excessive relative to Pakistan’s ability to repay it. Over the last decade,
proceeds from exports have not made up for the low investment and
declining assistance inflows, in particular from the United States, thereby
raising Pakistan’s debt stress.
Like its economic meltdown, Pakistan’s terrorism crisis, predominantly
driven by the TTP, is also self-inflicted. The TTP’s resurgence is
fundamentally driven by the rise of the Taliban in Afghanistan—who were
supported by Pakistan to counter purported Indian influence in the
country. U.S. officials had tried to reason with Pakistani leadership that
their support for the Taliban was feeding the TTP, but Pakistani officials
remained confident in their ability to both fight the TTP and support the
Taliban. At one stage, the TTP was weakened by U.S. drone strikes and
Pakistani military campaigns. The group retreated to the mountains of
eastern Afghanistan. But the Taliban takeover in Afghanistan has given
the TTP a massive boost. Almost instantly, the Taliban provided the

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TTP’s top leadership with political asylum and cover for its campaign of
violence in Pakistan.
Today, the TTP has thousands of fighters ready for a war against
Pakistan. The TTP’s leadership has found safe haven in Afghanistan,
where many Taliban fighters are also now joining the TTP. Pakistan has
repeatedly asked the Taliban to restrain the TTP. In return, Pakistan has
offered to advocate for the Taliban’s normalization with the rest of the
world and dangled economic inducements, such as expanding transit trade
and bilateral Afghan-Pakistani trade. In 2022, Afghanistan under the
Taliban sent over $1 billion in exports to Pakistan and raised significant
revenues from taxes on border crossings between the two countries. Still,
the Taliban remain unmoved in maintaining their support for the TTP.
Some Taliban leaders, in particular Interior Minister Siraj Haqqani, have
on occasion yanked the TTP’s leash. But most Taliban leaders back the
TTP’s political agenda and its campaign against Pakistan.
FROM BAD TO WORSE

Pakistan is facing the prospect of an economic collapse because of a

depletion of foreign exchange reserves and, in turn, a total disruption of
imports. There are two paths to this misery: one in which Pakistan, in the
near term, successfully renegotiates with the IMF and convinces Middle
Eastern and Chinese partners to issue new loans and roll over old ones but
because of substantial debt obligations, weak exports, a drop in
remittances, and low direct investment, the country’s financing needs will
still become unmanageable later in 2023. The other possibility is that
Pakistan remains stuck in a back-and-forth with the IMF, continues to
drain its foreign exchange reserves, and eventually ends up unable to pay
for imports.
As Pakistan drifts toward an economic abyss in both scenarios, it will
face significant pressures from the TTP. These pressures will be different
from those Pakistan faced from the TTP a decade ago. Back then, even
though the violence was dire, the United States was providing over $1
billion in yearly aid, targeting terror groups through drone strikes within
Pakistan, and fighting the Taliban in Afghanistan. This time, Pakistan

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lacks aid from abroad, and the Taliban in Afghanistan are much stronger.
Pakistan can hit back through cross-border assaults on the TTP but that
may only incite violent reprisals from the group and rile the Taliban,
leading to a bloodier conflict.
The TTP will look to press its advantage by increasing the number of
attacks, including suicide bombings, and contest for territory in the
country’s northwest. This will also afford opportunities to a range of
transnational and regional terrorists to establish bases in TTP-dominated
territories in Pakistan. At that point, Pakistan’s inability to import enough
oil will erode its military and policing capacity. The TTP will also have an
opportunity to exploit public anger caused by the economic meltdown and
commodity shortages. With Pakistan slated to have a general election in
2023, political turmoil in the country will worsen. All this will put
substantial stress on the cohesion of Pakistan’s army, which is already
reeling from Khan’s accusations that the military colluded with the United
States to remove him from power.
ONE WAY OU T

In Washington, Pakistan’s current predicament does not elicit much

sympathy, as U.S. officials remember Pakistan’s efforts to undermine their
war effort in Afghanistan. Pakistan’s troubles also serve as a reminder that
its leaders made reckless economic choices and engaged in dangerous
brinksmanship with terrorist proxies. Competing priorities and a shift
away from counterterrorism limit U.S. interest in addressing Pakistan’s
crises. Letting Pakistan stew in its juices also appears compelling—
particularly as this may be more painful for China, which is heavily
invested in Pakistan.
Still, there are U.S. interests at stake. Even if the United States is not
looking to outbid Beijing’s development finance and military transfers to
Pakistan, Washington is better served by a sovereign Pakistan free from
China’s coercion. Dissuading Pakistan from spoiling Indo-Pacific
priorities is also a critical objective. In addition, it is important for the
United States to deter transnational terrorist threats from Afghanistan and
Pakistan and ensure the security of Pakistan’s nuclear weapons. Should the

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economic crisis and the terrorism escalation begin to feed off each other,
these interests will come under stress. China may step in with last-minute
assistance, but that will mitigate neither the economic conundrum nor the
problem of mounting terrorist violence. Instead, it may pile on more debt
and come with coercive terms, such as Chinese demands for more military
basing and intelligence access—a decidedly negative outcome for the
United States.
Given these risks, the pragmatic way forward is to attend to the twin
crises with the aim of preventing them from happening simultaneously. To
this end, the United States should press Pakistan to reckon with the
reality of the Taliban’s support for the TTP and scale back economic ties
with and diplomatic advocacy for the Taliban, who have cruelly banned
women and girls from schools, universities, and nongovernmental
organizations. Separately, the United States should expose the Taliban’s
continued dangerous support for international terrorists, including the
TTP. In addition to hosting Ayman al-Zawahiri, the late chief of al
Qaeda, the Taliban are in violation of the U.S.-Taliban Doha accord and
several of their own pledges to not let their territory be used by
international terrorist outfits.
On the economic front, the U.S. government cannot and should not
offer Pakistani elites the shortcuts that they seek, such as by interceding
with the IMF for a reprieve on reforms. Instead, the United States should
push Pakistan toward a debt-restructuring process, similar to the ones Sri
Lanka and Zambia are in. The G-20 Common Framework program for
debt relief, meant for countries poorer than Pakistan, provides a template.
Pakistan will need a new IMF program even after it completes the current
one—and the United States should push Pakistan to start the
restructuring process now. Much of Pakistan’s debt is owed to multilateral
institutions, China, Paris Club countries, and private creditors that can
relax repayment terms in exchange for a plan of genuine reform that
makes long-term expenditure cuts while also mapping ways of boosting
Pakistan’s tax revenue, investment, and economic growth. Pakistani elites
will try to avoid the pain and reputational cost associated with
restructuring and perhaps the anger of their Chinese allies, who may

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oppose it to avoid losing money or setting a precedent. But if Pakistan can

successfully renegotiate debt repayment terms with other major creditors,
China will be left with no option but to restructure, too. That will reduce
China’s leverage over Pakistan and diminish the risk that China would
strong-arm Pakistan for military access. On the other hand, if Pakistan
remains in debt distress and the Taliban continue to support the TTP, it is
inevitable that Pakistan will stumble into an economic crash when
terrorists are becoming more brazen.

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