Rising inflation, the balance of payment crisis, and the depreciation of the rupee have raised the concern of default for one of the most populous nations in the world. For the last few months, the Pakistani government has been struggling to deal with the economic and political crises that have amplified the noise of Pakistan’s default.
Many people on social media are comparing the current economic crisis to Sri Lanka’s, but these comparisons, in fact, lack a solid basis.
In May, Sri Lanka defaulted on its debt payments and plunged into a deep economic crisis when its foreign exchange reserves fell to a historic low. This year, Sri Lanka was due to pay more than $7 billion in foreign debt to various creditors.
However, it had foreign exchange reserves of only $1.6 billion. Hence they were unable to pay for essential imports and clear foreign debt.
On the other hand, the situation is a lot different in Pakistan. According to the State Bank Acting Governor, the country will be able to meet the $33.5 billion external financing needs for this year, refuting the claims of default from various economists.
He added that the country has $35.9 billion in financing through multilateral loans and rollover of bilateral loans. He also added that Pakistan’s fiscal position is much better compared to Sri Lanka and other defaulting nations.
With Pakistan reaching staff level agreement with the International Monetary Fund (IMF) for the disbursement of a $1.17 billion loan, the situation is expected to improve in the coming days.
|Pakistan’s Foreign Exchange Reserves|
|Current Account Deficit|
|Why Isn’t Pakistan Going to Default?|
Pakistan’s Foreign Exchange Reserves
The talk of default gained a lot of traction last week when the rupee depreciated by Rs. 17.4 against the greenback in the interbank market in just a week. These disorderly movements in the currency markets, coupled with depleting foreign exchange reserves, have caused uncertainty among investors.
However, according to the central bank chief and Finance Minister Miftah Ismail, the market players are overestimating the situation as it is not as dire as they think.
Recently, in a meeting with foreign investors, the Acting State Bank Governor stated that once the inflows arrive from IMF and other friendly nations, the rupee will stabilize at around 200 against the dollar.
According to the central bank, the country’s total foreign exchange reserves are $13 billion, of which $9.2 billion is in the foreign exchange account, and $3.8 billion is in gold. Considering these figures, the central bank has enough buffer to bridge the financing gap for this fiscal year.
SBP’s acting governor expects the talk of default to dissipate in the coming week as the country will receive funding from the IMF.
Current Account Deficit
The underlying cause of the balance of payment crisis is the current account deficit that shoots up each time growth of over 5% is achieved.
According to the latest stats, the current account deficit stands at $17 billion in the fiscal year 2022. The increase in the current account deficit is due to the increase in the import bill.
The import bill for the July-May period stands at $72.1 billion for the current fiscal year, compared to $50.8 billion during the same period last year. This increase in the import bill is largely due to petroleum products that soared to $23 billion in the fiscal year 2022 from $10 billion in the last fiscal year.
On the other hand, Pakistan has exported $28.8 billion of goods and services for the fiscal year 2021-2022. Despite encouraging export numbers, the trade deficit has reached $43.3 billion in the current fiscal year.
To tackle the balance of payment crisis, the government has banned non-essential imports.
Why Isn’t Pakistan Going to Default?
Following are some factors the Pakistani government has managed well compared to its counterparts.
- Import dependence
- Exchange rate
- Foreign-currency debt
Pakistan and Sri Lanka are import-dependent countries as they import most of the essentials. As mentioned earlier, fuel has the biggest impact on import bills, which has cost $23 billion in the current fiscal year.
However, the Pakistani government banned non-essential imports from dealing with the increase in import bills. It has increased fuel and energy prices as well, which will help in curtailing the trade deficit.
The Sri Lankan government, in contrast, has not taken any initiatives to correct these macroeconomic imbalances.
Pakistan’s flexible exchange rate system and tight monetary policy have caused the rupee to depreciate as soon as it was subject to external pressures.
On the other hand, the Sri Lankan government kept its currency overvalued, which eventually proved catastrophic. This flexible exchange rate system allows the Pakistani government to improve the situation before a crisis strikes the economy.
Foreign Currency Debt
The debt Pakistan has to pay in the coming months is similar to Sri Lanka’s. However, Pakistan is a relatively bigger economy and has the capacity to pay its foreign debts for this year.
The tight monetary policy and decline in the value of the rupee all point toward a decrease in consumption in the future. With some commodity prices decreasing globally, the chances of default will dissipate in the coming days.
However, the next 12 months will be challenging as the government has to alter its growth targets accordingly and set policies to reduce the current account deficit as soon as possible.
For more information about the current economic situation, visit Graana blog.