The principal causes of Pakistan’s economic mess are deep-rooted and structural—namely, weak export base and an imbalance between public spending and income, says a CSR report while examining to what extent is Chinese lending to Pakistan a cause, or contributing factor, of Pakistan’s crisis?.
The principal causes of Pakistan’s crisis are deep-rooted and structural—namely, weak export base and an imbalance between public spending and income. Exports are a much smaller share of the Pakistani economy than other countries of relative economic standing—8% of GDP in 2017, compared to 20% in Turkey and 52% in Thailand. IMF forecasts faster growth for imports than exports through at least 2023. In recent years, security concerns and energy supply problems have prevented Pakistan from diversifying its export base from low-value added products such as cotton, rice, and leather, to higher-value products and, more crucially, services.
Pakistan’s economic growth has been relatively robust since 2012, reaching 5.7% in 2017. However, growth rates are below that needed to keep pace with Pakistan’s rapid population growth and import needs.
The IMF projects Pakistan’s growing current account deficit and rising debt service will cause its external financing needs to increase sharply in the years ahead. Gross external financing needs are expected to rise from $21.5 billion (7.1%of GDP) in FY 2016/FY 2017 to around $45 billion by FY 2022/FY 2023 (9.9% of GDP).
According to data from the State Bank of Pakistan, the current account deficit (imports of goods and services minus exports of goods and services) for FY 2017/ FY 2018 (ending in June) reached $18 billion, up nearly 50% from $12.6 billion in the previous year.
The current account deficit puts substantial pressure on Pakistan’s foreign exchange reserves and the value of the Pakistani rupee, which declined over 11% against the dollar during 2018.
This pending crisis may make Prime Minister Khan’s vows to create a “Muslim welfare state” with new public services and job creation difficult to realize.
It may also have negative implications for China’s vast BRI, within which the China-Pakistan Economic Corridor (CPEC) is the flagship initiative. CPEC is a planned connectivity effort, valued at an estimated $62 billion that includes major new road, rail, and energy projects for Pakistan.
Dwindling Exchange Reserves
Over the past two years, Pakistan’s foreign exchange reserves have dropped by more than half, from a high of $24 billion in October 2016 to just over $10 billion in August 2018(Figure 2).At the same time, its external liabilities remain formidable. These include repayments (through 2026) on Pakistan’s 2013 IMF loan and various foreign exchange forward and swap arrangements. For example, in May 2018,Pakistan agreed to a $3.1 billion reserve currency swap arrangement with the Peoples Bank of China, increasing its access to China’s RMB, a more stable and convertible reserve currency.
While borrowing from China temporarily supported the Pakistani balance of payments and prevented an immediate crisis—and Islamabad may also consider multibillion-dollar loans from the Saudi-based Islamic Development Bank—experts consider it unlikely that Pakistan will be able to return to capital markets without a robust and stringent IMF program.
The Trump Administration has taken note of Pakistan’s growing debt to China and expressed opposition to any international bailout that would provide funding to reduce such debt.
A CPEC Reset?
Featured CPEC projects include construction within all main sectors of Pakistan’s transportation infrastructure, boosting energy capacity and distribution, and developing a deep-water port at Gwadar on the Arabian Sea.
The new Pakistani government appears likely to scrutinize CPEC projects more vigorously than its predecessor, especially given a singular focus on corruption amidst ongoing concerns about the pace and quality of Chinese investments to date.
Khan and his party seek to move Pakistan away from the high-visibility, high-cost Chinese-financed infrastructure projects championed by the previous government; rather, they would prefer to redirect public spending toward the provision of basic services.
The Pakistani foreign minister hosted his Chinese counterpart in September, vowing to preserve CPEC as a top priority of his government. At the same time, other Pakistani officials have promised to review and renegotiate some CPEC-related agreements.
A subsequent Pakistan-China meeting resulted in agreement to expand CPEC activities into the social sector, with proposed initiatives on potable water, health, and education. If pursued, these would better align CPEC with the Pakistan government’s emphasis on human welfare.
In an effort to move ahead on unrealized plans to establish several special economic zones (SEZs) in Pakistan, negotiators also agreed to welcome “third-country investors.”
Press reports suggest Pakistani officials are also pressing Chinese counterparts to establish new factories and pursue poverty-alleviation initiatives. Anew nine-member Pakistani committee on CPEC, chaired by the planning minister, appears to seek more private-sector Chinese investment that would employ more Pakistani suppliers and labor. It is not clear how this “realignment” of CPEC goals will be paid for.
To date, no Chinese manufacturing has relocated to Pakistan and none of the nine envisioned SEZs has been established (with only four such zones now planned).
Meanwhile, the city of Gwadar reportedly has seen little or no new industry, chronic water and electricity shortages continue, construction on a planned airport and power plant has yet to begin, and virtually no commercial shipping uses the port.
Issues for CONSIDERATION
•To what extent is Chinese lending to Pakistan a cause, or contributing factor, of Pakistan’s ongoing economic crisis?
•If the IMF lends to Pakistan, what economic reforms are most essential?
•How can the United States help Pakistan boost its exports?
•What are the economic and policy implications of China’s apparent growing influence in the region?
•What are the potential implications of diminished U.S. influence over Pakistan if it seeks bilateral financing instead of support from the IMF, where the United States is the largest shareholder?
— excerpts from a CSR report