Pakistan’s Crippling Economy

Pakistan’s current economic situation is very worrying, and prime minister Imran Khan will have a mountain to climb to get the economy back to its feet. Almost all financial indicators have seen a downward trend, with the growth rate falling by almost 50 percent, and is expected to go down even further next year, which will be the country’s lowest in the past 10 years.

The Pakistani rupee has lost a fifth of its value against the dollar since the beginning of this fiscal year, as well as inflation expected to reach a 10-year-high. If these trends continue, Pakistan could be facing a major economic crisis in the next years. In this article we will examine the historical background of the Pakistani economy, the causes of this economic slump in recent years, as well as the Pakistani government’s plan to avoid a looming economic crisis.

Background

Between the late 1940s and the end of the 2000s, Pakistan has transitioned from a low-income to a lower middle-income developing economy. In the years after its inception in the late 1940s, Pakistan underwent an era of emergence as a new national economy. This continued into the 1950s, as Pakistan’s economy moved away from dependency on agriculture and diversified, prominently through plans like the Colombo Plan in 1951, when Pakistan instituted a series of Five-Year Plans during the period 1955-1998 and a Ten-Year Perspective Plan alongside a rolling Three-Year Development Plan.

Pakistan also underwent a period of industrialisation which was accelerated by the Korean War (1950-1953). With the help of incoming American aid, Pakistan sustained this high rate of economic growth throughout the 1950s and 1960s.

This was followed by an era of socialism in the 1970s, as because of growing inter-regional economic disparity, East Pakistan revolted against West Pakistan and became independent as Bangladesh in 1971.

Then, the martial law authorities empowered the socialist Pakistan People’s Party. This led to a period of economic weakening, as inflation rose to an all-time high between 1972-77, and poverty rose fast. This was also caused by the global recession that had broke out in this period.

The 1980s signalled the revival of the economic growth Pakistan had enjoyed before the crisis, largely due to the reversal of the nationalisation programs installed in the 1970s. This resulted in a manufacturing exports boom as well as the return of stable agricultural growth. In the 1990s, Pakistan confronted the problems of declining worker remittances and rising external deficits.

In the wake of declining growth rates of GDP, there occurred the second worst inflation in the 1990s. There was a sharp rise in unemployment, poverty rose fast, and external debt tripled between 1980-1995.

Debt crisis of the 1990s was followed in the 2000s by an era of macroeconomic crises. In spite of improvement in the growth rate until 2004-05 when the growth rate was 8.6%, the subsequent years were characterized by growth slowdown and low growth along with high inflation, energy crisis, and deterioration in fiscal and balance of payments positions. This continued until Pakistan was hit by an economic crisis in 2008, and by march 2010, Pakistan had acquired a very high public debt when compared to the GDP.

Nevertheless, the history of Pakistan’s economic development highlighted the key role played by the manufacturing sector. Pakistan progressed from its status as a low-income to a lower middle- income country and achieved her objective of poverty reduction.

Another economic crisis?

The economic situation in Pakistan today is worrying, as analysed by economists. Almost all financial indicators have seen a downward trend. The growth rate fell by almost 50 percent from 6.2 percent to 3.3 percent. It is expected to go down even further to 2.4 percent next year, which will be the country’s lowest in the past 10 years.

The Pakistani rupee has lost a fifth of its value against the dollar since the beginning of this fiscal year. Inflation is expected to hover around 13 percent over the next 12 months, reaching a 10-year-high as well.

Imran Khan came to power last August, inheriting an economy plagued with problems but he was initially deeply reluctant to turn to the IMF, which has provided more than 20 bailout packages to Pakistan over the decades.

However, despite securing billions of dollars in loans from friendly countries including China, Saudi Arabia and the United Arab Emirates (UAE), mounting economic headwinds forced his government to turn to the fund.

With foreign exchange reserves shrinking to only $7.3bn, less than the equivalent of two months’ worth of imports, and the budget deficit set to top seven percent of gross domestic product this year, Pakistan faces tough economic medicine to tackle problems that have been years in the making.

The country has low sources of revenues and high non-development expenditures, which is a recipe for a financial disaster. For decades, the Pakistani authorities have been unable to establish effective tax collection practices.

Currently, only one percent of Pakistanis pay their taxes and the country has one of the lowest tax-to-GDP ratios in the world. Successive governments have avoided imposing stricter controls because they have been staffed by members of the same elites that are actively evading taxes.

They are able to do so not only because of government inaction but also because of widespread corruption. In fact, it is cheaper for them to bribe than to pay their dues.

Hence, the tax burden in Pakistan falls overwhelmingly on the poor who pay in various indirect ways and who already struggle to make ends meet.

Currently, a third of the nation is living below the poverty line. Khan promised to crack down on tax evasion and corruption before coming to power but little has been done so far. He has not introduced any measures to address corruption in the ranks of his own party, for example.

Recently it emerged that a minister in Khan’s cabinet had evaded paying taxes for years by transferring his luxury properties to one of his employees, but no action has been taken against him so far.

In mid-June, a government survey painted a dismal picture of the economy, with a 3.3 percent growth rate. Then Khan released his first budget, full of austerity measures including salary freezes for civil servants and a 13 percent cut in military expenditures. Khan pleaded with the nation for patience, vowing that stability would return soon.

Already, the tough measures, especially plans to impose new business taxes, have spurred protests by traders and strike threats by mill owners. But Pakistan’s army chief expressed strong support for the government’s actions, an unusual gesture that underscores the severity of the crisis. 

The International Monetary Fund’s executive board has approved a three-year $6bn bailout plan requested by the government of Pakistani Prime Minister Imran Khan to resuscitate the country’s ailing economy. The IMF had reached a staff-level agreement for the loan facility on May 12.

In a statement recently, the IMF said the loan will help reduce public debt and expand social spending. But the IMF has attached some tough terms, including a commitment to let the market decide the Pakistani rupee rate, rather than allowing it to be supported by the Central Bank.

The rupee has plunged more than 40 percent in the last year. The first IMF disbursement will be $1bn, with the remainder to be phased in over the period of the programme subject to quarterly reviews, the IMF said.

The IMF wants Pakistan to increase the proportion of its people who pay taxes and for the government to reduce public debt. With slowing growth, a budget deficit which has climbed to more than 7% of GDP and currency reserves of less than $8 billion, or enough to cover 1.7 months of imports, Pakistan has teetered on the edge of a debt and balance of payments crisis.

The 2020 budget, passed last month, approved tax measures worth some 1.7% of GDP to help cut the deficit and Pakistan has promised a multiyear effort to overhaul its tax and budget system to put its public finances on a firmer footing.

A central part of the program will involve cleaning up accumulated debts in the power and gas sectors and in loss-making state enterprises including Pakistan International Airlines, Pakistan Steel Mills, and Pakistan Railways.

The historical fluctuation and patterns of the Pakistani economy has shown that for sustainable growth, Pakistan needs to significantly increase national saving and investment rates, achieve budget surpluses for minimising her domestic and external debt burden, and have political stability to promote a healthy investment climate for domestic and foreign investors, high levels of investment in human capital, and greater openness to international trade and private foreign investment.

If Pakistan is to avoid the looming economic disaster, it must revise current spending and prioritise expenditures that will actually generate social and economic development and uplift the poor, not just the civilian and military elites. It remains to be seen whether the IMF’s bailout plan will be enough to save Pakistan from a looming economic catastrophe.