The level of economic uncertainty in Pakistan today is truly unprecedented.

The political turmoil leading to a lack of clarity on the timeline of the upcoming elections and a delay in receiving the much-needed financial assistance from the International Monetary Fund (IMF) is exacerbating the situation.

Foreign exchange reserves touched one of their lowest levels in the last couple of decades, business confidence is shattered, inflation is at its highest-ever level, imports have significantly reduced and the rupee is continuously depreciating. It is imperative that the government receives the IMF financing as soon as possible to bring some respite in the face of these horrific economic conditions.

A recurring crisis

Pakistan faces balance-of-payments related challenges, driven by a burgeoning trade deficit, every few years because of which the country has had 23 arrangements with the IMF over the past few decades.

The current programme with the lender was agreed to in 2019 when the country faced another balance-of-payments crisis. Since then, the IMF has disbursed about $4 billion to Pakistan, with a balance of $2.6 billion remaining. However, Pakistan has yet to receive any disbursements from the IMF in 2023 as talks with lender reached a stalemate with the government unwilling to follow stringent conditions.

The root of the crisis is Pakistan’s inability to finance its external debt payments as dollar outflows significantly outpace inflows — dollar revenues generated via exports are simply not sufficient to pay for imports. As a result, every few years, our foreign exchange reserves start to tumble and investor confidence in the economy tanks.

Hence, the government relies on inflows from worker remittances and financial support from multilateral and bilateral donors as well as commercial lenders. Unfortunately, poor economic management and failure to improve the level of competitiveness in the Pakistani economy leads to this vicious cycle repeating.

Here, we analyse this trend through some key indicators that help us understand why Pakistan seems to be perpetually facing a balance-of-payments crisis.

All the numbers are taken from the State Bank of Pakistan except for the percentage of short-term debt to total reserves, which is sourced from the World Bank’s World Development Indicators.

Forex reserves

The foreign exchange reserves held by the State Bank of Pakistan (SBP) are presented in Figure 1. As you can see, the trend is volatile: Reserves increase when Pakistan receives financing from the IMF and decrease as soon as the disbursements from the IMF stop.

Pakistan arranged two IMF programmes under the Extended Fund Facility (EFF), designed to provide financial assistance to countries facing balance-of-payments issues, in the last decade.

The first EFF was agreed to in 2013 and the second in 2019. The first programme expired in July 2016 and the second one is set to expire on June 30.

Pakistan received a Rapid Financing Instrument worth $1.35 billion from the IMF in April 2020 as a response to curtail the economic effects of the Covid-19 pandemic. The trend in the foreign exchange reserves held by the SBP as shown in Figure 1 clearly follows the disbursement schedule of the IMF loans. When these disbursements cease, we see reserves slumping. The current impasse with the IMF is only worsening the situation.

Current account

The current account balance — which is the difference between dollars earned and dollar spent — between July 2013 and February 2023 is presented in Figure 2.

This figure has an inverse relationship with foreign exchange reserves. On the one hand, a deficit in the current account balance (when we are spending more dollars than we are earning) adds pressure to the reserves as dollar payments exceed receipts. On the other hand, administrative controls as well as import tariffs and other restrictions on the outflow of dollars, often imposed when foreign exchange reserves are shrinking, result in narrowing the deficit — at times even forcing a current account surplus.

The current account surplus in 2020 was due to the disruption of the global trading system as a result of the pandemic. Economic incentives provided to alleviate the challenges during the pandemic resulted in the current account balance once again running high levels of deficit. Pakistan previously reported higher current deficits between 2016 and 2019 when China Pakistan Economic Corridor (CPEC) related investments increased, resulting in greater import demand. The deficits were then reduced, when the reserves shrank to dangerously low levels, by imposing strict restrictions and measures on import payments.

In the current crisis, Pakistan reported high levels of current account deficit in 2022, which was reduced through different trade-related measures which eventually led to a current account surplus of $654 million in March 2023.

Import payments and the sum of export receipts and worker remittances are presented in Figure 3. Naturally, the current account deficit is higher when import payments exceed the sum of export receipts and worker remittances.

The sum of export receipts and worker remittances were relatively flat before 2021. Since then, incentives were introduced to not only encourage export receipts and worker remittances but better banking facilities, such as digital banking services, were provided to facilitate inflows. Pakistan saw exceptional growth in exports, remittances and imports post the Covid-19 pandemic.

However, the trend in import payments has been more cyclical, increasing as import demand rose between 2016 and mid-2018, and decreasing when restrictions were imposed to curtail the current account deficit, followed again by an increase as the economy recovered from the pandemic. Again, restrictions were imposed on import payments starting mid-2022 to protect the country’s reserves and fend off a possible default as pressure accumulated due to the increasing gap between outflows and the inflows in 2021.

Business confidence

Results of the various indicators reported in the business confidence surveys conducted by the SBP in collaboration with the Institute of Business Administration, Karachi, is presented in Figure 4.

The business confidence index surveys measures opinion on economic conditions, the level of production and the total number of employees. The purchasing manager index surveys measures perception on changes in production levels, the total number of employees, total order books, quantity of raw material purchases, and average supplier delivery times.

The indices were largely below 50 between October 2018 and August 2020, suggesting poor economic conditions and low confidence levels in the business sector. This vastly changed as the government introduced various incentives to recover from the pandemic-related economic shock in 2020.

From then on, scores of more than 50 were reported till April 2022, when political turmoil and economic uncertainty took its toll on business confidence. Since then, all the indices reported in Figure 4 have been on a downward spiral.

These numbers essentially mimic the trend in the current account balance and the foreign exchange reserves held by the SBP. As the government struggled with the balance-of-payments crisis, the business community’s perception of the economy also suffered. When the level of foreign exchange reserves improved and the economy recovered from the earlier shocks, so did business confidence. However, it is important to note that the improvement in business confidence also led to a higher trade deficit (as imports increased), which eventually drives the balance-of-payments crisis. Hence, it is essential to address the lack of exports.

External debt

As Figure 2 shows, Pakistan reported a current account surplus for 15 months since July 2013. The recurring deficit often requires Pakistan to finance its payments by increasing its external debt because dollar inflows are inadequate to meet its obligations. In essence, this increases Pakistan’s external debt.

Pakistan’s total public external debt — including government external debt, debt from the IMF and foreign exchange liabilities — between March 2010 and December 2022 is presented in Figure 5.

The figure stood at $52 billion in March 2010 and increased to $60 billion in March 2016. Since then, it rose rather sharply to $102 billion in December 2021, more than doubling from the December 2013 level.

With the government paying off some of its external debt in recent months, the amount of total public external debt decreased slightly to $97.5 billion in December 2022. The government’s external debt in December 2022 was approximately $79 billion. As Pakistan relies heavily on multilateral donors to finance its way out of its recurring balance-of-payments crisis, this amount is likely to increase with new disbursements from the IMF.

The share of commercial loans and multilateral and bilateral loans in public external debt is presented in Figure 6. Pakistan reported commercial loans in the quarter ending March 2014 by tapping into the international capital markets. Commercial loans tend to be non-concessional and come at less generous terms than concessional loans obtained from multilateral and bilateral sources.

Starting with a meagre $150 million in March 2014, commercial loans increased to more than $10 billion in December 2021, making up around 10 per cent of Pakistan’s total public external debt. Since then, however, commercial loans have reported a slight dip, and now constitute around 7 per cent of the country’s total public external debt.

Pakistan has mostly relied on multilateral and bilateral debt from donor agencies and friendly countries. The share of multilateral and bilateral debt dipped from more than 45 percent in March 2014 to less than 33 percent in March 2019 as Pakistan turned to commercial loans. However, the share multilateral and bilateral loans increased to more than 37 per cent in December 2022, and is likely to increase further as Pakistan will rely on them to mitigate the current balance-of-payments crisis.

The share of commercial loans and multilateral/bilateral debt serviced as a proportion of public debt servicing in Pakistan is presented in Figure 7.

More than $13.2 billion worth of principal payments on public debt were made by Pakistan in 2022. This was approximately $5 billion more than the amount of debt serviced each year from 2019 to 2022. A major anomaly was reported in the last quarter of December 2022, when $4.8 billion worth of principal payments were made.

As seen in Figure 7, in December 2022, the share of commercial loans accounting for debt servicing is higher than the share of multilateral and bilateral loans. With the increase in commercial loans in the last few years, their share in debt servicing is expected to increase. This adds to the country’s challenges as commercial loans tend to be non-concessional in comparison to multilateral and bilateral loans.

Short-term debt as a percentage of total reserves for Pakistan and Sri Lanka is presented in Figure 8. This is debt with original maturity of one year or less and interest in arrears on long-term debt.

There is significant debate on whether Pakistan and Sri Lanka are facing a similar crisis. It is important to note that although both countries need external financing, Sri Lanka has accumulated larger short-term debt as a percentage of total reserves than Pakistan. This value was reported at 274 per cent in 2021 for Sri Lanka, compared to 40 per cent for Pakistan. Although the figures worsened in 2022 as economic conditions continued to deteriorate for both countries, Pakistan’s exposure to short-term debt is much lower than Sri Lanka’s.

In essence, the sharp fall in the foreign exchange reserves, as witnessed once again in recent months, drives the vicious cycle that pushes us into a balance-of-payments crisis every few years. As the 23rd arrangement with the IMF draws to a close, it is highly likely that Pakistan will be seeking a 24th arrangement with the IMF. This again will involve financing to provide necessary foreign exchange reserves and an impetus to the economy.

However, this time it seems that the IMF has been tougher in imposing its conditions as it delays the disbursement of crucial funds. It is yet to be seen what policy actions will be taken once the funds are received and short-term relief is provided.