It has been a tumultuous year for Pakistan, and not just politically. Even though discussions centred around Imran Khan’s ouster and ‘foreign conspiracies’, the economy also remained in the spotlight. If you heard doomsday cries of “Pakistan is defaulting” or “We’re the next Sri Lanka,” but were unsure of exactly what was going on, you’re not alone.
As the year draws to a close — with discussions of default and dollar rates still not dying down — Dawn.com answers some of the questions you may have about the economy.
What is default and if it happens, how would it affect my life?
Simply put, if Pakistan defaults, it means it has failed to pay its debts because it does not have the dollars to do so. Consequently, Pakistan would be locked out of debt markets, possibly for years and unable to import essential items such as petrol, gas and vegetables. Without fossil fuels to generate electricity, there would be widespread blackouts and industry would grind to a halt.
What are these dollar reserves? And why does SBP keep on running out of them every now and then? What happens if they fall to zero?
Foreign exchange reserves are the assets denominated in a foreign currency (the US dollar in this case) held by the State Bank of Pakistan (SBP). These include but are not limited to foreign currencies. The reserves are used to pay back debts owed by Pakistan, and for imports. Since Pakistan is a heavily import-dependent country and its imports outnumber its exports, the reserves are usually under pressure.
Not all of this is due to imports though. Foreign exchange reserves are also used by the SBP to influence the USD-PKR exchange rate. In the past, especially during Finance Minister Ishaq Dar’s previous stint, if the SBP wanted to bring down the exchange rate, it would release some of its reserves into the currency market. This would increase the supply and thus, cause the exchange rate to drop. However, under the most recent agreement with the International Monetary Fund (IMF), the government is bound to not interfere with the exchange rate.
As for what would happen if the SBP ran out of dollar reserves: we would default.
Why is dollar so expensive to buy with my rupees this year? What has changed?
There are two main reasons for this. Locally, the government has let the market determine the rupee’s value, which has caused it to fall against other currencies, but especially the dollar.
In addition, Pakistan’s foreign reserves have been critically low recently while the country’s import needs have risen after the floods, which is why the dollar demand is much higher than what is available, causing the USD-PKR rate to shoot up.
The second reason is more complex and related to the US Federal Reserve’s decisions. As inflation in the US rose this year, its central bank a.k.a. the Federal Reserve decided to raise interest rates. This made it more attractive for investors to purchase the USD — the most traded currency in the world — and use it as a “safe haven” since they would get higher returns. The increase in demand has led to the dollar’s value rising to its highest in decades.
- Strong US dollar an unstoppable force endangering other currencies
- How a strong dollar affects the economy — and your wallet
Why have petrol prices gone through the roof this year? What’s caused this?
To understand why petrol prices have risen to decades-high, we will have to go back all the way to the Covid-19 pandemic, which thankfully seems distant now. As lockdowns were imposed around the world, demand for oil declined and producers cut output levels. However, when the pandemic eased a bit, there was a surge in demand, leading to a rise in prices.
While the energy market was still “fragile”, Russia launched its invasion of Ukraine. As a result, Western countries decided to impose a price cap on Russia, the world’s top producer of crude and oil products combined, which came into force on Dec 5. This raised fears of tight supplies and prices shot up to decades-high.
Meanwhile, the Organisation of Petroleum Exporting Countries and allies including Russia, collectively called Opec+, cut output levels which also caused prices to jump.
Iran, which could ease supply concerns, is already under Western sanctions because of which its oil production is reduced.
Higher oil prices in the international market meant that not only did your commute get expensive, your electricity bill also went up because Pakistan uses oil and coal to generate a large part of its energy.
Another factor that has made fuel more expensive is the rupee’s declining value against the dollar. Since Pakistan imports oil, it has to pay for it in dollars, which means it gets more expensive as the rupee’s value falls.
What is inflation and what is this CPI I hear about every now and then?
Inflation is simply a rise in prices. It is measured by the Consumer Price Index (CPI), which calculates the monthly change in prices of a basket of goods.
In Pakistan, this basket of goods comprises 12 categories, including food and beverages, clothing and footwear, housing and utilities, transport and education. To calculate the CPI, the Pakistan Bureau of Statistics measures the prices of 356 items from urban areas and 244 items from rural areas.
So, how do you make sense of it? In October this year, the transport sub-index of the CPI rose 53.43pc compared to October 2021. This means your transport costs increased 53.43pc compared to the same period last year.
As to why inflation has risen so high this year, it comes back to three main reasons: higher oil prices, which made transport more expensive; the rupee’s fall, which increased the cost of imports; and the floods which caused heavy agricultural losses, leading to Pakistan importing vegetables.
What is current account deficit?
A current account is a measure of all the foreign exchange a country earns through exports and remittances or loses through imports and loan repayments. Thus, a current account deficit occurs when a country’s outflows exceed its inflows.
While a current account deficit is not always a bad thing as a country can be taking debt to finance investments that will pay off later, for Pakistan, it has become a chronic problem since it imports heavily while its exports do not grow at the same rate.
What is balance of trade?
Simply put, it is the difference between a country’s imports and exports.
What is circular debt and why is it such a big problem for energy companies?
A circular debt, also described as a cash shortfall across the power supply chain, is accrued when the power purchaser fails to pay the power producer for electricity generation. Over the years, circular debt has ballooned in Pakistan due to a number of reasons including system losses, electricity theft and power subsidies.
If energy companies are not paid their dues, they will, in turn, have trouble paying for fuel and be unable to improve their infrastructure, thereby affecting the viability of the entire system.
If the stock market is rising, does it mean the economy is doing well?
The stock market can be influenced by a number of factors, including speculations and political developments. Therefore, its movement cannot be tied to the state of a country’s economy.
What does it mean that the economy is growing? And every time it grows rapidly, why does it also tank just as fast? What does “the economy is overheating” mean?
The state of a country’s economy is measured by its gross domestic product or GDP. If the GDP — the total market value of all the products a country produces — is rising, it means the economy is growing. The keywords in Pakistan’s case, however, are boom-and-bust cycles.
Whenever Pakistan’s economy starts growing, imports also start rising as machinery is brought from abroad to manufacture products. This results in an outflow of foreign exchange, which could be covered by profits from exports in the long run, except Pakistan’s exports are not diverse or market-competitive and are unable to keep pace with the imports. This leads to an overheating economy — when the economy is growing at an unsustainable rate and inflation keeps rising.
Eventually, the central bank raises interest rates, and then comes another period of economic decline or growth contraction.
Why is a petrol subsidy actually bad for you? Why should the government not cut fuel or power prices?
If the government provides a fuel subsidy, it effectively pays for the difference in the price at which the fuel was purchased and the price at which it is sold from the treasury. For Pakistan, which already has limited foreign exchange reserves, giving subsidies amounts to unnecessarily spending money that should instead be kept for loan repayments and limiting the risk of default.
If Pakistan can generate more electricity than we need, then why do we still have loadshedding?
Transmission and distribution losses, including technical inefficiencies and theft, and a low revenue recovery ratio, i.e., the fraction of bills paid by consumers.
What is credit default swap rate and why is its rise so alarming?
A credit default swap is a type of insurance against the risk of sovereign default. For example, an investor buys a bond issued by the Pakistan government and also goes to an investment bank to buy its CDS. This means they sign a formal swap agreement under which the bank promises — against a fee or premium — to compensate the bondholder should Pakistan default.
The important bit to understand here is that these figures are bought and sold in the over-the-counter market, which has no proper exchange. Hence, there’s no singular CDS rate.
If the CDS figure is 75.5 per cent, it means the bondholder would, on average, have to pay $75.5 to an investment bank to secure or insure every $100 that it’s lending to the Pakistan government.
A higher CDS rate reflects that there are fewer banks willing to act as a guarantor for Pakistan’s bonds, thus limiting the country’s access to investors.
Compiled by Urooj Imran.
Header photo: Illustration from Shutterstock