On the verge of default

Pakistan once again finds itself on the verge of another default. The alarming situation of the State Bank of Pakistan’s (SBP) foreign exchange reserves has become increasingly disconcerting. The reserves held by the SBP have decreased to $6.7 billion, which is approximately 1.4 months in terms of import cover. Comparatively, the foreign exchange reserves in December, 2021 were approximately $17.6 billion.

A sharp decline was witnessed in March, 2022, when nearly $5 billion were wiped out from the reserves as they plunged from $16.4 billion in February, 2022 to $11.4 billion in March, 2022. This decreasing trend has continued since as dollar inflows are limited at a time when Pakistan is expected to pay off its external debt.

Currently, there is a significant shortage of dollars in the currency market and the wedge between the interbank rate and the open market, and the ‘hawala’ rate is significantly high. Import restrictions along with restrictions on foreign payments have been imposed by the government as a precautionary measure to curtail the pressure on the Pakistani rupee. Unfortunately, with the presence of large informal markets, these restrictions have little tenacity. They only give impetus to informal exchange in the currency market.

The SBP governor has stated on record that the debt repayment situation is under control, and all obligations will be met on time. The purpose is to alleviate the concerns regarding the default on external debt obligations. The country needs to pay approximately $23 billion in debt obligations, of which $10 billion have been rolled over. The SBP has further assured that out of the remaining $13 billion approximately $8 billion with be further rolled over. These repayments are either multilateral loans or commercial loans. The main issue pointed out is the dearth of foreign exchange inflows into the country. This is obvious as exports have perpetually remained stagnant between $20 billion and $30 billion in the last decade. Any growth in exports is likely to be difficult to achieve in the current scenario as import restrictions are likely to impact the imports of critical raw materials and intermediate goods necessary to produce exportable output.

According to the Pakistan Bureau of Statistics’ data, exports in November, 2022 decreased 17.6 per cent year-on-year – from $2.9 billion to $2.3 billion. Exports in the first five months of FY23 decreased 3.4 per cent – from $12.4 billion to $11.9 billion. Exports of textile products declined by 5.1 per cent in the first five months of FY23, with exports of bedwear and towels decreasing by 13.29 per cent and 4.5 per cent respectively. Exports of tents, canvas and tarpaulin have increased by 20 per cent and that of readymade garments have increased by a meagre 1.2 per cent. Although the food group witnessed only a decline of one per cent, exports of rice decreased by 9.3 per cent, while exports of fruits and oil seeds, nuts and kernels decreased by 37.2 per cent and 25.8 per cent respectively. On the other hand, exports of vegetables, meat and meat preparation and fish and fish preparation have increased by at least 20 per cent.

As Pakistan faces a looming crisis on the external front, it needs to undertake policies that encourage export growth. A decline in exports of certain major products is worrying. Remittances, which had in the previous year recorded its highest levels, are also decreasing. The shift in preference towards informal currency markets is also increasing the challenge of receiving remittances through formal channels, which in turn increase the foreign exchange reserves held by the SBP.

Considering the data on imports, the stranglehold on import payments by the government to alleviate the balance of payment concerns is apparent. Imports in November, 2022 were reported at $5.1 billion, 34.4 per cent less than the amount imported in November, 2021. The imports in the first five months of FY23 decreased by 20.5 per cent in FY22. Although they did increase by 10 per cent from October, 2021, the policy to reduce imports has not only affected the flow of consumer goods into the country but also the necessary intermediate goods and raw materials that are required to produce exports. Machinery imports decreased by 42.35 per cent year-on-year in FY23, with a decline in imports of commodities within the group. Imports of textile machinery decreased by 41 per cent and imports of power generating equipment decreased by 71 per cent.

Considering the imports of textile products, which decreased by 17 per cent year-on-year in the first five months of FY23, imports of synthetic fibre decreased by 38 per cent. Although import of raw cotton increased by three per cent, the quantity of its imports has declined by 10 per cent. Transport group imports decreased by 47 per cent, with imports of completely built-up units and knocked down units decreasing. Imports of petroleum group have decreased by eight per cent, driven by the rise in prices of petroleum products in the domestic market. In essence, the government has taken measures to discourage imports and the data suggests that this has resulted in a decline in imports across all major commodities, some of them essential to the production of domestic goods as well as exports.

The large-scale manufacturing index for July to September FY23 decreased by 0.4 per cent. Although this amount is minimal, the increase during the same time period in the previous year was phenomenal – at 10.2 per cent. Several of the major sectors that have reported high growth rates in the previous fiscal year observed a decline this fiscal year. The sharp volatility in the trend is due to not only economic uncertainty, but also due to political uncertainty that has led to a tumultuous economic environment.

The State Bank of Pakistan publishes the Business Confidence Index bi-monthly in joint collaboration with the Institute of Business Administration, in Karachi. Their indicators are useful predictors for the economic conditions prevalent in the country. The performance of the business confidence index, the employment index and the capacity utilisation have been below par in the last few waves, suggesting relatively poor economic conditions in the country.

The policymakers must address the disconcerting economic conditions on a priority. It is highly essential that they secure the financing much needed to alleviate the balance of payment concerns that are currently signalling that the country is likely to default on its external debt obligations. The financing from the IMF is extremely critical in this case. The IMF’s financing makes it easier to negotiate with and obtain funds from other multilateral donors. The government is trying to roll over much of its bilateral debts obtained from friendly countries. Such efforts must continue.

It is also essential to obtain trade finance for the import of essential commodities such as oil and other petroleum products. Pakistan has become ever more dependent on its major trading partners and other donor agencies to fulfil its financing needs. Several measures are being recommended to curtail economic activity in Pakistan such as early closure of markets and restrictions on petrol consumption. These short-term measures are not only likely to create further inefficiencies in the long-run, but are regressive, as the richer segment of the society can easily evade the measures in a society where rent-seeking activities are rampant.

In essence, the government’s utmost priority should be to finance the gap in the balance of payments rather than impose restrictions on economic activity across the country.

The writer is Assistant Professor of Economics and Research Fellow at CBER, Institute of Business Administration, Karachi