“Midway upon the journey of our life I found myself within a forest dark, For the straightforward pathway had been lost.” — Dante
PAKISTANIS find themselves once again in familiar territory – on the cusp of yet another economic crisis. While the country has endured frequent balance of payments-induced crises in the past, this one is different. To understand what is different about the current crisis, one needs to revisit the typology of economic crises.
While economic crises come in many forms, broadly, they fall into four categories: currency crises, ‘sudden stops’ (related to disruption in external capital inflows or sudden outflows), debt and banking crises. In terms of taxonomy, these types are generally referred to as ‘financial crises’. The triggers for these crises are either exogenous shocks or endogenous policy excesses. A terms of trade shock is an example of the former, and refers to a collapse of export prices or a sustained surge in import prices faced by an economy — as experienced by many import-dependent developing countries in the wake of the Russo-Ukraine conflict.
Crises resulting from sudden stops are usually caused by a flight-to-safety of internationally invested capital in response to the US Federal Reserve raising interest rates. A debt crisis results from an inability to service (usually external) debt obligations due to falling foreign exchange reserves in relation to debt servicing, while a banking crisis emanates from systemic failures in a country’s banking sector.
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Although there can be, and usually are, overlaps between the four types of crises, with a crisis initially starting off as one type and then morphing into another, Pakistan’s external account crisis episodes can generally be traced to large external trade imbalances caused invariably by policy settings being too lax, leading to ‘overheating’ in the economy. Large fiscal deficits and/or excessive credit and money creation have often been to blame for this type of crisis. However, during the 1990s, there were two episodes when Pakistan faced balance of payments stress due to a terms of trade shock as well as a ‘sudden stop’ caused by the US Fed tightening monetary policy.
Pakistan is on the cusp of an unprecedented economic and political crisis.
What makes the current crisis unique in Pakistan’s recent history, is that the impending crisis ticks all the boxes (barring, for now, a banking crisis); the external account is under pressure due to a combination of import prices having spiked sharply since early 2021, as well as too-accommodative domestic policy settings. The US Federal Reserve has begun a sharp course correction by raising interest rates, which will impact the availability as well as pricing of external private capital available to countries like Pakistan. And Pakistan’s external debt repayments profile is markedly elevated for the next few years. The resulting gross external financing requirement is estimated to be around nine per cent of GDP — in a similar range to 2018, and pretty much as unsustainable.
The path of the crisis and its implications are going to be fairly similar to what was experienced in 2018, with one crucial difference — severity. The magnitude of this crisis is, unfortunately, likely to be unprecedented. The confluence of pressures from several fronts, amid a world in turmoil, has already taken its toll on several vulnerable emerging markets, and Pakistan is unlikely going to be an exception. Hence, the need for much greater agility in course correction in policy settings than is being currently shown.
The impending economic crisis will be amplified by the political (as well as judicial) crisis that has engulfed the country with the heavily engineered removal of the PTI government. The installation of a wobbly rainbow coalition, with legitimacy as well as credibility issues, for an ‘interim’ time frame will impede the whole-of-nation response that the crisis of this magnitude demands. Facing the real possibility of a popular movement against it, and heading into elections sooner rather than later, will blunt any impulse for meaningful reforms from the administration — as will the disparate coalition of political parties and interests holding the government together.
Under these circumstances, what needs to be done? The short-term impulse of arranging external financing while avoiding course correction (what Paul Krugman termed “over-financing and under-adjustment”) needs to be avoided. The correction of the excesses in the policy mix should have started and is past due. (Following through on the energy and grains deals with Russia initiated by the previous government will provide an important breather — but requires a spine that is currently missing in Rawalpindi as well as Islamabad.)
For a more durable recovery, the political crisis will have to be resolved through free and fair elections that brings in a legitimate government with a fresh mandate. A strong government reflecting the will of a majority of the country needs to be in place to institute the difficult road to economic recovery. The anchor of the recovery road map should be a clear and comprehensive plan for institutional and structural reforms. This plan should be formulated by a high-powered ‘National Reforms Commission’ under the elected prime minister, which should also be entrusted with overseeing implementation.
The ‘National Reforms Commission’ should not be constituted on the template of the various economic advisory councils formed in the past. A major difference should be that it should not consist of businessmen, or just a small group of economists. It should bring into service an eclectic group of professionals, including inter alia practitioners in change management, organisational design and development, organisational and behavioural psychology, HR, among others, to formulate and oversee plans for restructuring of government and civil service (taking advantage of the corpus of work already done under Dr Ishrat Husain’s stewardship), state-owned enterprises, public financial management, institutions of economic governance (FBR, State Bank, Planning Commission, Securities & Exchange Commission of Pakistan, Board of Investment etc), and the major sectors of the economy such as exports, agriculture and industry.
This is a long road to recovery with no ‘silver bullets’ or shortcuts. Without a grand design for institutional and structural reforms, as well as an overhaul of its governance model, Pakistan will continue to slip further into an economic and political morass.
The writer is a former member of the prime minister’s economic advisory council.
Published in Dawn, May 8th, 2022