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Economic Fallout of Pakistan’s Political Crisis

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Economic Fallout of Pakistan’s Political Crisis

Should Prime Minister Shehbaz Sharif take populist steps like reducing energy prices, Pakistan could go down the same route as Sri Lanka.

Economic Fallout of Pakistan’s Political Crisis

At street hawker sells his wares outside the Tomb of Lal Shahbaz Qalandar in Sind, Pakistan, August 19, 2016..

Credit: Wikimedia Commons/Naeemcanon

Pockets of political instability, economic uncertainty and social unrest are unfolding across Asia and Latin America, Africa and even Europe. European countries are struggling with an energy crisis and its effects are being felt across the globe. Governments are facing serious challenges in the wake of inflation that doesn’t seem to be “transitory” at all. Food prices are off the charts. Sri Lanka is experiencing a full-blown economic crisis and protestors are calling for the resignation of the Rajapaksas. As in this South Asian country, in Peru protestors have taken to the streets. They have forced the government to impose a state of emergency. Pakistan is the latest victim of this political instability, which could, unfortunately, spread to other countries.

Pakistan’s Prime Minster Imran Khan was recently ousted in a no-confidence vote. He is the country’s only prime minister to be removed from power through a vote of no-confidence. At midnight on April 9-10, 174 legislators in the 342-seat House voted against his government. Allegations of foreign intervention, although without evidence, played a pivotal role in the drama. While this political drama was nothing short of a movie plot, the economic consequences of these events can be dire for the common man and the government, as well.

Inflation in Pakistan is expected to cross 15 percent by summer and with U.N.’s Food and Agriculture Organization showing record-high food prices through its Food Price Index, which now stands at 159 – the highest since it was formed in 1990 – this will put further upward pressure on food prices in Pakistan. The country is already suffering from a double-digit inflation. Food prices have registered an uptick of 14.5 to 15.5 percent in March on a year-on-year basis and experts have already warned about an impending threat to food security, which I had highlighted in an article in The Diplomat back in December 2021. Food prices are directly correlated with an increase in social unrest.

Furthermore, Pakistan may also face a serious balance of payment (BoP) crisis as the State Bank of Pakistan’s reserves have fallen to a perilous level of $11 billion, which is not enough to even cover one-and-a-half months of imports. The country’s reserves dropped by a whopping $5 billion in one month (of March). Imports are on the rise as highlighted by the fact that 52.2 percent of the recent increase in tax collection came from imports. The country’s trade deficit stands at a concerning $35 billion. With reserves alarmingly low, Pakistan is expected to service liabilities of $2.5 billion in the ongoing quarter alone (April to June). The composition of our reserves is also tenuous with most of it being debt financed. The IMF and China have given Pakistan $6.7 billion and $6 billion. respectively, with the rest of it coming from Saudi Arabia ($2 billion), UAE ($2 billion) and other assets.

Due to the current scenario, Pakistan’s fiscal deficit is expected to touch almost $24 billion, the highest ever on record. Pakistan’s total liabilities have also crossed $27.6 billion.

In this scenario, the new government under Prime Minister Shehbaz Sharif faces a dilemma: Should it use populist measures such as further reducing energy prices to win votes in next year’s general elections or take strong, necessary steps that would render it instantaneously unpopular.

Doing the former will put Pakistan on the same path as Sri Lanka. The need of the hour is to increase prices, especially of petrol and petroleum levy that will give the government much-needed funds. As of now, against an expected non-tax revenue of $3.3 billion, the government will be getting only $55 million due to relief in petroleum levy. However, the new government has already started off by extending a relief package that includes, among other things, a 10 percent increase in pensions and wheat subsidies.

How long will these measures last?

When the government will need to make an about-face is hard to predict. However, the international context helps us in surmising that the about-turn will be very soon.

Rising COVID-19 cases in China will further prolong the disruption of already troubled supply chains across the world. This will result – it already is – in rising business costs that will be then passed onto the consumers.

The most important factor is rising inflation on a global scale. The U.S. Federal Reserve has adopted a hawkish stance which means that they will continue to raise interest rates that will further strengthen the dollar against a basket of other currencies putting further fiscal pressure on developing countries. The dollar index is already at 100, a two-year high. With Pakistan’s reserves at the aforesaid level and the sword of debt financing hanging low, it will find it increasingly difficult to survive without taking concrete steps. Help can come from the IMF (and China) but this could lead to rising prices.

The existence of panic in the commodity and financial markets; a global inflationary spiral, rising food prices, and a surge in protests especially in emerging markets, shows that this process will not be confined to Pakistan or Sri Lanka only.