Zafar Iqbal

Pakistan’s economic landscape in early 2025 has raised concerns as the country’s current account posted a deficit of US$420 million in January, ending a streak of three consecutive months of surpluses. This shift, along with the country’s second consecutive month of a financial account deficit, has triggered anxiety about the nation’s overall economic stability. The balance of payments, which measures the difference between a country’s incoming and outgoing money, is also in the negative, further compounding the unease.

One of the most pressing issues is the sharp decline in the State Bank of Pakistan’s (SBP) foreign exchange reserves. Over the past nine weeks, the central bank’s reserves have dropped by a staggering US$900 million. As of January’s figures, reserves now cover just over two months of imports, an alarmingly low level. The threat of a panic situation is tangible, and as such, Pakistan must prioritize building its reserves to stave off an economic crisis.

Unfortunately, efforts to replenish these reserves have been slow and fraught with difficulty. The SBP Governor recently disclosed that the central bank purchased about US$9 billion from the interbank market throughout 2024, helping to boost reserves and service the country’s external debt. Between June and October 2024, the SBP bought US$3.9 billion, allowing the bank to pay both interest and principal repayments on foreign debt. This strategy, while initially effective, is facing significant challenges. As economic demand increases, the SBP’s ability to continue purchasing dollars is becoming more limited.

The central bank typically buys dollars from the interbank market, sourcing them mainly from bank treasuries. In 2024, the interbank market adhered to the principle of managing inflows and outflows based on the market’s needs. Some banks, especially those with strong import businesses, consistently sold dollars to the SBP, and the market followed these norms. However, the beginning of 2025 has proven to be a tumultuous period. With the current account slipping into deficit, the interbank market is now facing an increased demand for dollars, and the SBP is struggling to maintain its purchases from the usual sellers.

This situation was somewhat anticipated by the authorities, and the plan was to attract foreign direct investment (FDI) and secure funds from the global debt market to counteract the slippage in the current account. The Finance Minister was tasked with leveraging his international banking connections to facilitate these inflows. However, despite these efforts, the anticipated inflows have not materialized. Even the International Monetary Fund (IMF) had expected to see these financial inflows and has been reportedly surprised by the sluggish response from investors.

There are two primary reasons behind this delay in inflows. The first is external: global factors are playing a significant role in keeping investors on the sidelines. US interest rates are not decreasing as quickly as initially anticipated, and the US dollar index is strengthening, which is making emerging markets, like Pakistan, less attractive to investors. This global environment has led to a pullback of capital from countries with more volatile or uncertain economic conditions.

The second reason for the lack of inflows may be domestic in nature: Pakistan’s political instability and the current regime’s focus on reviving growth while maintaining an artificial stability of the Pakistani rupee (PKR). As the US dollar strengthens, the PKR has appreciated against other currencies, raising concerns among investors. The currency’s volatility, combined with domestic political uncertainty, has made it difficult for Pakistan to create an environment that would entice foreign capital.

As of now, no significant dollar inflows have arrived, leaving the SBP under considerable pressure to maintain a current account surplus. Without a surplus, the country’s foreign exchange reserves will continue to deplete, exacerbating the economic crisis. The government must adopt a more strategic approach to demand management in early 2025.

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One of the immediate measures being taken by the SBP includes maintaining restrictions on auto financing and encouraging banks to hold surplus dollars. This has led to delays in contracts and payments, with banks reportedly slowing down the opening of Letters of Credit (L/Cs) for imports. This, in turn, could lead to a depreciation of the currency by several percentage points. While interest rates may not drop to single digits in 2025, the federal government is likely to continue running a primary surplus, with low inflation and slow economic growth persisting into fiscal year 2026. The country appears to be stuck in a cycle of low growth and low inflation, with no immediate resolution in sight.

In this context, the government’s best course of action is to implement structural fiscal and energy reforms that can help create an export-led growth culture. These reforms, though difficult and time-consuming, are vital for the country’s long-term economic health. Export-led growth has the potential to reduce Pakistan’s reliance on foreign loans and build the reserves necessary to cushion against external shocks.

To facilitate this shift, Pakistan must focus on bolstering its industrial base and boosting exports. By diversifying its export sector and strengthening industries such as textiles, agriculture, and manufacturing, the country can tap into global markets and reduce the trade deficit. Additionally, fostering a more conducive environment for foreign investment, through both policy and infrastructure improvements, will be essential in attracting much-needed capital.

A comprehensive approach to energy reform is also critical. Pakistan’s energy sector has long been a drain on the economy, with rising costs, inefficiencies, and a lack of investment. Reforming this sector will not only help reduce energy shortages but will also enable industries to become more competitive on the global stage. By addressing the energy crisis and improving infrastructure, the government can provide businesses with the stability they need to grow and expand, further strengthening the economy.

Moreover, fiscal discipline is paramount. The government must work towards improving tax collection mechanisms, reducing fiscal deficits, and prioritizing spending on productive sectors like education, healthcare, and infrastructure. Structural fiscal reforms will help create a more sustainable economic model that relies less on external debt and more on domestic resources.

In conclusion, Pakistan is at a critical juncture. The challenges of a slipping current account, declining reserves, and sluggish foreign inflows are daunting, but they are not insurmountable. With a focus on structural reforms, particularly in fiscal policy, energy, and exports, Pakistan can lay the groundwork for long-term economic stability. However, the government must act decisively and swiftly, as the window of opportunity for avoiding a full-blown economic crisis is closing. Without these reforms, Pakistan’s economic struggles will likely persist, and the nation will remain at the mercy of global forces beyond its control.