Chronicle of a crisis foretold

Only the IMF team’s arrival today offers a glimmer of hope that we will be able to stave off default

The writer is a former Deputy Governor of the State Bank of Pakistan. He tweets at @murtazahsyed

With just $3.7 billion left in foreign exchange reserves, Pakistan is once again staring into the abyss. Only the IMF team’s arrival today offers a glimmer of hope that we will be able to stave off default. Eighteen months of smoke and mirrors have brought us to the edge at home and damaged our standing abroad. It did not have to be this way.

Cast your mind back to March 2021. Pakistan had successfully resumed its two-year-old IMF programme, which had been paused due to the global Covid outbreak. During the one-year hiatus, Pakistan had received global acclaim for its management of the pandemic. Pakistan’s economic rebound from Covid was one of the world’s most impressive. Growth had picked up strongly while government debt had fallen by 6.5% of GDP, the current account was virtually balanced and foreign exchange reserves had increased by almost 50% to $17 billion. Scarcely a year and a half ago, then, we were a global success story.

Despite the overt successes of the Covid period, however, Pakistan’s structural problems were still far from solved. Pakistan’s growth model remained driven by consumption and imports, while both the tax take and exports continued to be lackluster as a share of GDP. So there was a still a lot of work to be done. Moreover, global commodity prices had begun to rise sharply and it was well-known that, after the temporary relief provided under the G-20 debt suspension initiative, Pakistan faced a wall of external debt repayments over the next 12 months. To pay for this sharply higher external debt servicing and the rising import bill, it was clear that Pakistan had to remain under the IMF programme. Tough as the IMF conditions were, there was no other way to generate the foreign exchange inflows that we needed.

This is where the story takes its first unfortunate turn. Hubris led to a premature declaration of victory. In July 2021, after two years of commendable frugality, the floodgates were opened through a hyper-expansionary FY22 budget. An unsuspecting public was seduced into believing the hocus pocus that growth would solve all of Pakistan’s problems, including magically raising tax revenue, boosting exports and reducing debt. Real estate, the most unproductive of all sectors, was celebrated as one of the main engines of growth. Tax breaks were handed out to the same old suspects. With little structural reform, growth was once again driven by the snake oil of fiscal largesse flowing to vested interests. In so doing, all the hard work of the previous two years was sacrificed and the seeds of discord with the IMF were sown.

Within 6 months, this ill-advised fiscal expansion, coupled with rising global commodity prices, predictably led to overheating and severe pressures on inflation and the current account. Sheepishly, the IMF was recalled and a supplementary budget passed to rectify some of the fiscal profligacy, paving the way for a successful review in February 2022. Some damage had been done to our relationship with the Fund. But with the current account deficit coming back under control and foreign exchange reserves remaining around $17 billion after touching an all-time high a few months earlier, the overall cost was still relatively limited at this stage. At least we were now back on track in a year we knew was going to be exceptionally tough, due to global funding markets being closed off and our external payments being at multi-year highs.

Or so we thought. The second unfortunate twist in the tale was the result of extreme political turmoil and populism. In the same month that the review was completed, fuel and electricity prices were slashed and frozen. This was against IMF commitments and contrary to international price developments. Even after the change in government, this unfunded subsidy was continued for another 3 months. It proved a major blow to relations with the IMF, from which we have yet to recover.

All told, this subsidy and lack of fiscal restraint by the new government created a large hole relative to the promised supplementary budget. Together with political instability, these adverse developments jeopardised what should have been a straightforward next IMF review in March 2022. Instead, the review dragged on until September, completed only after the energy subsidies had been rolled back and a tough FY23 budget agreed. Bitten twice, the IMF was no longer in a forgiving mood.

This six-month delay was extremely costly. The energy subsidies and other fiscal slippages saw the import bill soar and contributed to excess demand, putting severe pressure on inflation, the current account and the rupee. To protect our foreign exchange reserves, sub-optimal temporary administrative curbs on imports became necessary while we negotiated our way back into the IMF programme. By the time the review was finally completed, foreign exchange reserves had fallen to $9.5 billion as foreign inflows dried up due to the impasse with the IMF, even as external debt repayments kept coming due. But again, we heaved a collective sigh of relief as we had at least returned to the IMF fold.

Alas, given our suicidal tendencies, this was too good to be true. It was now time for the third and unkindest self-inflicted cut of all. I do not need to dwell on the disastrous consequences of the policy regime of sound and fury that we watched unfold over the last 4 months. They are splashed all over our newspapers and plain for all to see. Its consequences will now be felt through another back-breaking round of inflation and austerity, whose severity could have been avoided if we had stayed on track. Today, we have run out of cards. We ran from pillar to post, desperately seeking for a bailout but no one trusts us anymore. All roads continue to lead to the IMF, as they have done for the last 18 months. We have known this all along but chose to delude ourselves that there could be some other fantastical option.

So there you have it. A tragedy in three acts. Like all tragedies, it did not have to be this way. We could have acted more responsibly. For instance, we could have been like Bangladesh, which had the foresight to approach the IMF for assistance early last year, at a time when their foreign exchange reserves were still north of $40 billion. But we chose to waver and deceive. The consequences will be a much harder landing in terms of growth, employment and inflation. We now also have a much deeper hole to crawl out of in terms of dwindled foreign exchange reserves and a severely diminished international reputation. It is this diminished reputation that enabled the international community’s lukewarm response to the very real tribulations unleashed by last summer’s catastrophic floods. We have only ourselves to blame.

Published in The Express Tribune, January 30th, 2023.

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