‘Analysts say Pakistan could still avert a default. Brad Setser, an economic policy expert at the Council on Foreign Relations in Washington, said the country must negotiate a “serious reprofiling” of its payments. Most of Pakistan’s external debt of around $100 billion is from multilateral and bilateral sources, including the Paris Club, a mostly Western group of lenders, the IMF and China, which holds about $30 billion. Only $8 billion of total debt is Eurobonds.’ – Excerpt from a February 23, 2023 Bloomberg published article ‘Pakistan faces the abyss again. Debate rages on who should pay’
Unlike a number of developed countries, including the USA, developing countries, like Pakistan, could neither provide anywhere near the needed level of stimulus– as a counter-cyclical policy, and to what extent it was practiced as an exception to the otherwise negotiated IMF programme, produced significant positive consequences in terms of economic and inclusive growth, something which the IMF itself acknowledged in one of its country reports, and barring the political instability and consequences of war in Ukraine, current account and subsidy initiatives, especially on the fuel and energy side also remained reasonably manageable as per reportedly announced government policy of PTI– during the pandemic-causing recession, nor do they find themselves with enough fiscal space to make needed non-austerity spending to move towards resilient and green economies.
Lack of domestic resource mobilization, a high level of imported inflation– especially in terms of food and energy costs in the wake of the supply chain crisis, which got even more accentuated due to the war in Ukraine– and high debt repayment needs have contributed significantly to such a squeeze.
Moreover, inefficiency in making current expenditures, and lack of institutional reforms of public sector enterprises sucking-in bailout expenditures eat away fiscal space. It needs to be clarified here that belt-tightening, cutting wasteful expenditure, or reducing inefficient expenditure is not austerity in the sense of economics literature, by which it means cutting down development expenditure.
Also, lack of provision of debt relief/moratorium under an overall meaningful debt restructuring mechanism in place on one hand as a combined effort by bilaterals, multilaterals, and private creditors, and inadequate provision of special drawing rights (SDRs) by the International Monetary Fund (IMF) added to the debt distress of developing countries, and contributed to the narrowing of fiscal space available to them.
In addition, lack of provision of climate finance has made it all the more difficult for developing countries, some of them, including Pakistan, being highly climate change vulnerable as well, to make the needed investments to move towards a green economy.
On top of that a number of countries in IMF programmes, like Pakistan, have been asked under IMF programmes to produce a ‘primary surplus’ that is even after making interest payments, bringing expenditures below the level of revenues, has meant that countries need to make a significant cut to their development expenditures. Sure, countries could and should increase tax base, and make it progressive in terms of taxation.
Yet, expecting these difficult political challenges in developing countries with decades of perpetuating elite capture to get dismantled in the face of quick demands of pandemic, high debt burden, and fast-unfolding climate change crisis is a virtually over-optimistic demand by multilaterals like IMF.
This is particularly misplaced optimism, given a weak spirit of multilateralism being brought to the table, whereby a much easier option of greater financial support – allocation of SDRs for instance – and larger debt relief could lead to a much-needed increased fiscal space. So, rather than expecting of developing countries to unshackle decades old grip of elite capture quickly, or else practice austerity, it is much better to support them financially and allow them to take the non-austerity, counter-cyclical policy route, whereby the world as a whole reduces poverty and inequality on one hand, and gets more prepared to face the existential threat of climate change crisis, and current and likely future pandemics.
In addition, lack of provision of climate finance has made it all the more difficult for developing countries, some of them, including Pakistan, being highly climate change vulnerable as well, to make the needed investments to move towards a green economy.
Here, it also needs to be indicated that the neoliberal mindset of multilaterals like IMF, for instance, in the shape of mainly tackling inflation mainly through policy rate, needs to be revisited given the significant supply-side determined nature of inflation calls for a more modest monetary tightening approach being practiced in both developed and developing countries; where in the case of the latter, inflation is at least equally a fiscal phenomenon ever in routine times, when there is no such global supply shock as is being faced in the wake of the pandemic, and accentuated by the war in Ukraine.
Over-board monetary tightening has caused two major problems, while it has added to inflationary pressures through higher cost push inflation in the case of developed countries, leading to strengthening of wage-inflation spiral, something that also gained strengthen from over-board stimulus provided during the pandemic, in the case of developing countries it has led to firstly, significant capital flight from developing countries, which not only put pressure on domestic currency and strengthened the imported inflationary channel, but also increased both external and domestic debt repayment levels; once again putting pressure on balance of payments, and added to imported inflationary channel.
Moreover, wrong policy of central banks in developing countries of following the trend of interest rate hikes in developed countries, to retard capital flight – that is attracting highly volatile foreign portfolio investment, or ‘hot money’ – added to cost of capital domestically, and in turn contributed to the cost-push channel of inflation, and weaker and less inclusive economic growth; since only the already established businesses could afford the rising cost of capital.
Having said, the cost of capital has risen so much that even large-scale manufacturing, including the main exports industry in the shape of textiles, has also taken a big production dip. Rising level of unemployment, in addition to rising level of inflation, even as austerity policies are being practiced – with economic growth rate, which was at around 6 percent during the closing months of last fiscal year, is now being estimated to just being in the positive, to around 2 percent!
Clearly, the IMF prescription, lack of SDR support, in addition to overall little debt relief being provided, along with government’s virtually non-existent, home growth, counter-cyclical, innovative policy, with greater progressive taxation, has meant the clouds of greater civil unrest, and debt default are only getting thicker. Ironically, having said, given a lack of reform policy response has only made it all the more important to keep the IMF programme alive, as an important source to avoid default, it strongly appears, at least for the short-term horizon.
Debt restructuring indeed will also play an important role, where in the absence of a well-functioning framework in place currently, which meaningfully allows all the creditors – bilaterals, especially China, multilaterals, and private creditors – to come together in a significantly effective way to help out developing countries in debt distress, it makes a lot of sense that Pakistan should start a restructuring process with China, to which it reportedly owes around one-third of its external debt.
At the same time, both higher cost push inflation, and cost of capital meant retarding the rate of economic growth, and with it lessening the domestic resource mobilization. In IMF programme countries, this has meant therefore, that no sustainable economic growth or debt repayment capacity gets built-up, in return for financial support brought through the programme. Instead, it just creates breathing space in terms of buying time for negotiating another IMF programme. On the other hand, pursuing austerity, and procyclical policies also does not allow moving towards a much-needed resilient, inclusive, green, sustainable economies.
The fact that developing countries have weak democracies in general, with weak capacities and willingness, and even intention by the elites – who otherwise have the political and economic power to strongly influence policy – to allow reform that increases tax base, for instance, significantly contributes to prolonging the misery of putting the economy on the lines indicated above. Having said, the fast-unfolding of existential threat in the shape of climate change crisis is quickly narrowing the window, and will not allow either domestic elites to continue to pursue extractive political- and economic institutional design, or domestic policymakers and multilateral institutions to practice neoliberal, austerity, and procyclical policy.
On the contrary, a non-neoliberal, non-austerity, counter-cyclical policy, on one hand, and a meaningful spirit of multilateralism on the other is needed, and in an urgent way to have a reasonable chance of effectively dealing with climate change crisis, and reduce high level of inequality; where the latter in addition to increasing negative economic consequences for the vast majorities of people globally, is also increasing political radicalization, and xenophobia, and overall, is weakening democracies.
