The Sick Man of South Asia

Pakistan’s economy remains in flux after it inked a newly brokered deal with the International Monetary Fund (IMF) to secure a $6 billion cash infusion over the course of 39 months. With as little as $8 billion of foreign reserves in state coffers, Pakistan subsists on a brittle economy in the short term and confronts deep, structural deficiencies in its economy for decades to come. Geopolitically, the country finds itself enclosed by American disenchantment and Chinese opportunism, increasing the difficulty of achieving economic diversification. Lacking sustained and critical reform, Pakistan risks prolonging its generational economic malaise.

In the immediate, Pakistan faces a bruising economic outlook, comprising of rising inflation and unemployment. The Pakistani rupee has plummeted against the dollar over the past year, losing one-fifth of its market value in total. With exchanges currently hovering around 150 rupees to the dollar, everyday Pakistanis are squeezed by escalating prices of imports. Kaiser Bengali, a distinguished Pakistani economist, suggested Pakistan’s dire situation could chronically worsen.

Because the government has minor impact influencing the economy, he conjectured the rupee could plunge even farther – to 250 rupees/dollar – in just one year’s time, a development that would far exacerbate the crisis. Further, the nation’s energy sectors have burned through innumerable loans managing to stay afloat. Unable to recompense these loans or attract new sources for loans, Pakistan’s government was compelled to increase prices across the board to salvage its cash-strapped industries, contributing mightily to inflation.

Apprehensive over the prospect of rampant inflation, Pakistan’s central bank moved swiftly to tighten its monetary policy regime. Interest rates spiked to a five-year high, from 10.75 percent to 12.25 percent in late May. The bank’s rate hike favorably serves two aforementioned policy objectives in Pakistan, reducing inflation and buoying the rupee at market exchange rates, but it introduces new obstacles into the real economy.

Pakistan’s capacity to issue loans to small businesses, individuals, and established ventures, previously constrained by its delicate fiscal order, will necessarily lessen in amount. Private actors, ceteris paribus, will be increasingly repelled from receiving loans due to higher interest rates. Most tangibly, this will affect the durability of infrastructure projects and expansionary plans for businesses, decreasing the rate of investment across the economy.

Additionally, ongoing investment will be subject to the interest rate hike; thus companies must allocate more resources toward their completions. Consequently, these economic actors will reduce their outside spending to accommodate for interest rate adjustments. Because options for saving money in bank accounts, for whom this option exists, appears preferential to spending at higher interest rates, consumption will be met with a similar precipitous decline. In tandem, the dual reduction in consumption and investment will impede direly needed economic growth, despite alleviating the excesses of inflation.

As such, Pakistan’s central bank slashed expectations of growth for the remainder of the fiscal year. Their projections suggest the dawdling economy will be met with a sizable fiscal deficit, another unwelcome episode amidst exhaustively adverse economic conditions. Pakistan’s foreign exchange reserves linger at dangerously low levels. While the IMF pledged to inject $6 billion into Pakistan’s economy, there are stringent preconditions to accepting aid. Pakistan was forced to introduce austerity measures into its next budget, stipulating a slew of spending cuts and a separate set of reforms in the energy sector.

Another requisite the IMF made compulsory was allowing the rupee to be free-floating by market forces. Pakistan’s state bank has interfered in years past to artificially buttress its currency, but the IMF’s requirement forbids this under the duration of the loan. Pakistani exporters are apprehensive about a floating currency because, as recent history highlights, market conditions can worsen instantaneously. Added uncertainty here accentuates investors’ uneasiness in conducting business with Pakistan.

American disengagement with Pakistan is a separate factor contributing to the country’s ailing financial situation. The Trump Administration withheld two installments of military aid last year, valued at $900 million and $300 million apiece, out of discontent for Pakistan’s duplicity in combating militant Islamic groups. Pakistan appeared publicly unconcerned by the blow, but its fiscal house could have ostensibly benefited by the timely, recurring cash flows.

More pressing is the government’s efforts to escape the “grey list” – a group of nations the Financial Action Task Force (FATF) categorizes for having responded weakly to mitigating terrorist activities within their borders. At the behest of American frustration, Pakistan was thoroughly vetted by the FATF, and in June 2018, was officially placed on the list. Membership to the grey list entails severe financial penalties, made possible through high impediments positioned on inflowing investment. The Pakistani foreign office tabulated the nation’s annual loss to be $10 billion for remaining on the list.

Despite having been globally ostracized for its present status, Pakistan has since invested little effort into demolishing terrorist networks internally, which could give the FATF credence for downgrading Pakistan to the “blacklist,” the severest possible classification citing non-compliance. Doing so would impose a moratorium on inward investment originating from foreign governments, an evidently higher cost for inaction. Ultimately the FATF is the final authority, but Pakistani non-compliance and apathy were entirely avoidable pitfalls that could have reclaimed untold billions for its faltering economy.

Apart from accepting the IMF’s bailout package, Pakistan has little recourse in attracting investment designed to boost its economy, that is, with the very extreme exception of China. Chinese investment in Pakistan, via the China-Pakistan Economic Corridor (CPEC), has injected many billions of dollars into Pakistani infrastructure projects, generating nearly one hundred thousand jobs in the country. Young Pakistanis have flocked to acquire Mandarin competencies, with the aim of obtaining employment in the transportation, infrastructure, and energy sectors as Chinese investments rapidly stream into these domains. Analysis compiled by the University of Karachi’s Applied Economic Research Centre (AERC) forecast CPEC producing “over 700,000 direct jobs” in Pakistan by 2030.

The flurry of Chinese investment has moderately stimulated Pakistan’s economy against the backdrop of major economic turmoil, but concerns are mounting about its overreliance on China. The Middle Kingdom is responsible for nearly half of Pakistan’s annual trade deficit, and its loans, with obscure and sometimes predatory conditions, are continually earmarked to break ground. China has a lengthy track record of economic manipulation against smaller states by seizing control, via “debt-trap diplomacy,” of strategic equity, primarily ports and military installations.

Given this troubling history, combined with Pakistan’s feeble economy and disproportionate reliance upon China, Pakistan could be the latest domino to drown amid the sea of Chinese investment in Eurasia. Take for example the Gwadar port, the lynchpin integrating China’s Belt and Road Initiative with the Maritime Silk Road in southwestern Pakistan. The port is discernibly a juicy target for Chinese primacy, derived from strategic and economic motivations. General Joseph Dunford, speaking on the solvency of the Gwadar port, declared in March that “Pakistan owes China at least $10 billion” on the port alone – a significant sum to reimburse.

Confined to a fiscally precarious position, it’s uncertain from where Pakistan could continually procure revenue to stave off a painful default. Current and emergent Chinese projects might cripple Pakistani finances by their sheer weight, but even if they do not, China will retain an inordinate degree of control over vital spheres of influence for the foreseeable future.

All told, Pakistan’s present and forthcoming economic dysfunction make it a vulnerable actor on the world stage. By striking the improbable combination of engendering high inflation and low growth, repelling the Americans, emboldening the Chinese, and succumbing to the IMF’s assistance, Pakistan’s flailing economy renders it the sick man of South Asia.

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