AVERTING sovereign default is important, so let’s assume we manage to do it. A more relevant question is why is Pakistan facing default?
Looking at the seven years from FY16 to FY22, Pakistan’s cumulative current account deficit was $74.5 billion, while the State Bank’s forex reserves fell by $3.6bn during this period. This means Pakistan needed financing of $70.9bn, and borrowed $65bn. Foreign investment barely financed the external deficit, so the government just kept borrowing. Since foreign creditors are reluctant to continue lending, Pakistan’s external sector has become unsustainable.
Dollar inflows (exports and remittances) have always lagged behind outflows (imported goods and services). This gap narrowed in FY20 (the IMF programme started) and in FY21 (Covid-19 was a positive boost for the economy); excluding these one-offs, Pakistan needed $11bn per year to finance its external deficit. Unfortunately, the country did not use this money to build a dollar repayment capacity, and now we’re stuck.
After decades of hearing the mantra that exports will double in the next five years, we have given up on textiles. Remittances have been a lifesaver, but these inflows cannot be managed, so Pakistan must reduce imports — and clamp down hard. There are two options: (1) emergency measures like delaying and prioritising imports; and (2) using orthodox policy tools to reduce import demand.
It is not just about averting default.
Pakistan has taken emergency measures since 2022 and is shifting to the IMF’s solution (ie, let the rupee and interest rates do the heavy lifting). The immediate goal is to sharply reduce import demand. We all know the IMF is ideologically opposed to ad hoc measures to slow imports as it creates distortions and is only a temporary fix.
The IMF is good at stabilisation but not so good at sustainable growth. Should the rupee be allowed to weaken to reduce Pakistan’s imports to sustainable levels? This policy option is regressive as it gives equal weight to importing luxury cars and essential foods — if the rich are willing to pay, they should be able to import a BMW i7. This policy is also highly inflationary, especially for a country that imports fuel and essential foods. And finally, ongoing rupee weakness will encourage dollarisation, undermining the banking system’s ability to channel funds from savers to investors.
What about hiking interest rates to reduce import demand? This would create a fiscal blowout, whereby the government would have to earmark its limited funds for debt servicing and forego other expenses like running the government and financing development. It would also undermine the health of the banking system via a sharp increase in loan defaults, and starve the private sector of credit.
Understandably, the government is against these neoliberal remedies, while the IMF is against what the State Bank is currently doing. So … is there a middle ground?
Given the large number of developing countries experiencing a debt-driven economic crisis, we think the IMF would be willing to accept a compromise solution. However, the lead would have to be taken by our policymakers, and their homegrown import strategy must be acceptable to the IMF. The challenge is to reduce imports without unleashing hyperinflation, avoid driving the banking system into the ground, and killing the private sector.
This requires an economic vision and long-term planning. It requires identifying winners and losers — those sectors that need help and those that need to fade away. It requires import substitution to manufacture intermediate and final products instead of importing them. Free market fundamentalists would take offence to this suggestion, claiming that ‘infant industries’ don’t grow into responsible adults but remain pampered children — like our textile sector.
Japan, South Korea, China and India started as inward-looking economies, but their economic managers had the wisdom and professionalism to ensure that winners became global leaders. Can we expect our policymakers to do the same? With our track record, this is near impossible. The more relevant question is whether we can pick ourselves from the ditch and return to the limping stage.
The elite is praying for a return to the good old days (say, three years ago) to avoid hard decisions that will hurt their interests. The policy challenge boils down to addressing Pakistan’s addiction to superfluous imports — more specifically, balancing the people’s needs against the short-term interests of the elite. The goal should be to allow the fruits of a stable, growing economy to lift all segments of society. However, looking at our policymakers in the past seven years, can anyone hope for this outcome?
The writer runs an advisory.
Published in Dawn, March 21st, 2023
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