Pakistan’s Economic Struggles: Are Reforms Enough to Avoid Default?

Zafar Iqbal

Prime Minister Shehbaz Sharif, in a speech at the ground-breaking ceremony for the first Daanish School Science and Technology Centre of Excellence in Bhimber, Azad Jammu and Kashmir, claimed that the government had “saved the country from falling into default” by addressing key economic challenges. His comments were made in the same week that Pakistan’s Finance Minister, Muhammad Aurangzeb, acknowledged Pakistan’s ongoing battle with its twin deficits—current and fiscal—and assured that efforts are underway to resolve them. Yet, while these statements offer a sense of hope, the reality remains more complicated, and Pakistan’s economic situation demands a deeper analysis.

At the core of Pakistan’s economic crisis lies a combination of persistent fiscal mismanagement, high external debt, and structural weaknesses in key sectors of the economy. Empirical data from the State Bank of Pakistan indicates some positive trends, such as an increase in remittances, which helped improve the current account deficit in the second quarter of the fiscal year. Remittances rose by 27%, reaching $9.04 billion, up from $7.1 billion in the same period last year. The overall balance, which includes the financial balance, also saw an improvement, with a positive inflow of $321 million in the second quarter, compared to a net outflow of $865 million in the first quarter of FY2024. However, while these figures may seem promising, they only tell part of the story.

The persistent reliance on external borrowings remains a significant concern. As of September 2024, Pakistan’s total borrowings had reached $133.5 billion, with the debt-to-GDP ratio standing at 67%, a decrease from 78% previously. This may appear to be progress, but it doesn’t diminish the underlying issue: debt remains unsustainable. Pakistan continues to incur loans just to service its existing debt, creating a vicious cycle where new loans are taken to pay the interest and principal on past loans. This approach not only places a massive strain on the country’s fiscal health but also leaves Pakistan vulnerable to the stringent conditions imposed by international lenders, such as the International Monetary Fund (IMF). These conditions, often involving contractionary policies, negatively impact growth, elevate poverty, and make it more difficult for Pakistan to build a stable economic future.

The situation is exacerbated by Pakistan’s unsustainable budget deficit, which has remained over 7% of GDP since 2018. A major driver of this deficit is unchecked current expenditure, which has led to rising inflation. While inflation has seen a slight decline in recent months, the cost of living continues to skyrocket due to several factors. Utility prices, for example, are regularly increased to meet full-cost recovery conditions set by the IMF, leading to a constant erosion in the quality of life for average Pakistanis. Additionally, private sector wages have failed to keep up with inflation for the past five years, primarily due to sluggish GDP growth, largely driven by a decline in large-scale manufacturing. This leaves the average worker with less purchasing power, contributing to the growing economic divide.

One of the most significant challenges for the current government is its reliance on indirect taxes, which make up 75-80% of total tax collections. These taxes disproportionately affect the poor, exacerbating inequality. Indirect taxes, which include sales tax and fuel levies, are inherently regressive, meaning they take a larger percentage of income from the lower-income population than from the wealthy. This further fuels the perception that the government is not doing enough to address the needs of the most vulnerable in society.

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Another critical issue is Pakistan’s relationship with international financial institutions, particularly the IMF. Since late 2023, the IMF has consistently refused to approve the next tranche of funding unless certain conditions are met. These conditions include fiscal reforms that, while necessary, have proven difficult to implement. The IMF’s refusal to release funds has prompted key international allies, including China, Saudi Arabia, and the UAE, to withhold essential financial support, particularly in terms of rolling over loans. This decision has left Pakistan’s foreign exchange reserves vulnerable, further weakening the value of the rupee.

The incumbent government, despite its claims of implementing reforms, has yet to deliver concrete results. Finance Minister Aurangzeb’s acknowledgment of the need for reform is a step in the right direction, but actions speak louder than words. Efforts such as the formation of committees to address fiscal challenges have not yet led to tangible outcomes. Furthermore, past governments have made similar promises with little to show for them, leading many to question whether the current administration can break the cycle of inaction.

It has been almost nine months since the government assumed power, and while there have been threats of rightsizing and stricter enforcement from the Federal Board of Revenue (FBR), no substantial reforms have materialized. The public remains skeptical about whether these promises will be followed through. Pakistan’s international credit rating remains in the junk category, further compounding the country’s financial difficulties. Despite never defaulting on its obligations, the IMF noted in October 2024 that Pakistan’s capacity to repay its debt is “subject to significant risks.” This statement underscores the magnitude of the challenges ahead and highlights the importance of implementing sound economic policies that can restore investor confidence.

In conclusion, while Prime Minister Shehbaz Sharif’s statement that Pakistan has been saved from default offers a glimmer of hope, the reality is much more complex. The country’s economic challenges are deep-rooted, and efforts to address them have thus far been insufficient. The government’s reliance on external borrowings, unsustainable fiscal deficits, and regressive taxation policies continue to undermine Pakistan’s economic stability. If meaningful reforms are not implemented soon, Pakistan may find itself facing even greater economic hardship. It is essential for the government to act decisively, prioritizing long-term solutions over short-term fixes, to avoid further deterioration of the country’s financial health and avoid a potential default.

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