Pakistan's Financial Crisis: The root causes ailing India's immediate neighbour

Pakistan's economic growth is massively hit by natural calamites. A report released by the Asian Development Bank on the country's projected growth rate reveals a shocking slowdown. 

According to the Asian Development Outlook (ADO) April 2023, ADB’s flagship economic report, Pakistan’s gross domestic product (GDP) growth is projected to slow to 0.6 per cent in FY2023 from 6 per cent last fiscal year as the economy struggles to recover. Growth is forecast to rise to 2 per cent in FY2024, assuming the resumption of macroeconomic stability, implementation of reforms, post-flood recovery, and improving external conditions. 

What ails India's immediate neighbour?

Some of the immediate problems Pakistan may be grappling with are a rising cost of food and gasoline which is hurting the average poor to middle-class person significantly. The damage caused by the 2022 floods has only made the country's economic problems worse. According to reports Pakistan's financing options beyond June are highly uncertain. Without an IMF package Pakistan could default considering its very weak reserves.

What has gone wrong in Pakistan?

1. High import rates for energy
2. Decreasing forex reserves
3. Global inflation
4. Political instability
5. Sustained drop in GDP growth

The Root Causes Of The Crisis

Pakistan's short-sighted policy decision, which resulted in significant spending on non-developmental and financially unviable projects, is mostly to blame for the current economy . Its problems were exacerbated by economic mismanagement, the funding of pointless infrastructure projects like the Gwader-Kashgar Railway line project through long-term loan instruments, and a heavy reliance on foreign borrowing rather than native institutions. The CPEC's (China-Pakistan Economic Corridor) rollout increased debt levels and made it easier to obtain ever-larger loans from abroad. Notably, the CPEC increased China's debt to Pakistan from US$47 billion in 2014 to US$64 billion as per ICWA reports.

Declining Value Of Pakistani Rupee

The steadily declining value of the Pakistani Rupee against the US Dollar has added to the growing external debt. Foreign investors stayed away due to declining confidence, low rankings by international rating agencies, and Pakistan's inclusion on the Financial Action Task Force (FATF)'s grey list. According to State Bank of Pakistan data, FDI inflows into Pakistan over the last 10 years have never gone above 1 per cent of GDP. Pakistan has fallen into the dreaded "debt trap" due to the vicious cycle of obtaining new loans and repaying existing ones. Furthermore, as a result of the international community's hesitation to grant Pakistan loans, the nation was obliged to rely primarily on China and Saudi Arabia, leaving it exposed to their onerous conditions. According to projections, industrial growth will continue to slow down in FY2023, which will be caused by tighter fiscal and monetary policies, a major devaluation of the local currency, and increased domestic oil and electricity prices.

Growing Trade Deficit

Due to rising import costs and declining exports, Pakistan has been grappling with a growing trade deficit. The trade deficit of Pakistan reached a record high of US$37.7 billion in FY 2018. In the first five months of  fiscal year, the trade imbalance increased by more than 117.25 per cent as per the ICWA 2022 report.  The fiscal deficit is projected to narrow slightly to the equivalent of 6.9 per cent of GDP in FY2023. Pakistan's trade-to-GDP ratio is among the lowest in the world, according to a ADB report. The issue was made worse by the Covid-19 pandemic epidemic. During the epidemic, there was merely any buyer for major exports including cement, textiles, leather, and sporting goods. The composition of Pakistan's trade basket shows that the country exports non-essential goods and imports those that are necessary such as items of domestic consumption, which has contributed significantly to the widening of the export-import deficit.

FOREX Erosion

The foreign exchange reserves in Pakistan have dramatically decreased as a result of a growing trade deficit and declining investment. In the second week of November 2021, foreign exchange reserves decreased by 1.97 per cent to US$23.550 billion from US$24.025 billion in February 2022. Additionally, commercial bank reserves decreased from US$6.699 billion in November 2021 to US$6.605 billion in 2022. The value of the current reserves decreased as a result of the Pakistani Rupee's devaluation against the US Dollar.

Increasing Inflation

November 2021 marked the peak of Pakistan's inflation. This is mostly due to rising freight costs brought on by an increase in crude oil prices globally. In addition, Pakistan imports a net amount of staple foods like sugar, wheat, and edible oils and oilseeds. Especially noteworthy is the fact that roughly 16 per cent of Pakistan's total imports are food. Global food price increases have an impact on Pakistan. High food inflation is attributed to a poor harvest from the previous sowing season. Over the past few years, there has been a significant rise in energy prices, which has put a lot of pressure on inflation and increased costs for the average person.

From 12.2 per cent in FY2022 to 27.5 per cent this fiscal year, average inflation is expected to more than double. Headline consumer inflation increased to 25.4 per cent in the first seven months of the fiscal year as a result of rising domestic energy costs, a weaker currency, supply interruptions brought on by floods, and import restrictions brought on by the balance of payments crisis. Pakistan, a net importer of both oil and gas, would continue to face significant inflationary pressures during the remainder of FY2023.