A report from an Islamabad-based think tank, Tabadlab, portrays a grim outlook on Pakistan’s financial health, characterizing the country’s debt situation as a “raging fire.” Pakistan is in a precarious situation with its escalating debt levels, facing the severe risk of default that could lead to a devastating economic spiral.
Pakistan’s total debt and liabilities have soared to $271.2 billion, which accounts for 91.7 percent of the GDP. The external debt and liabilities rose dramatically to $124.6bn, which is 42.1 percent of GDP, while the total domestic debt and liabilities have reached $146.6bn, equivalent to 50 per cent of GDP.
Pakistan’s domestic debt of Rs 42.0 trillion is not as worrisome as its external debt. Pakistan’s government, with its sovereign guarantees and being a sovereign issuer of local currency, ensures it never faces a shortage of funds or defaults on domestic debt. However, a large proportion of the federal budget (40 percent) is allocated to interest servicing on domestic debt, which hinders the government’s capacity to invest in crucial areas such as social protection, health, education, and meeting the country’s climate goals.
Pakistan’s foreign debt level, which is 42.1 percent of GDP, is lower in comparison to countries that face zero or minimal default risk despite the fact that their foreign debt surpasses their GDP. Consider countries such as the United Kingdom, Japan, Singapore, Hong Kong, and others that have foreign debt exceeding their GDP.
Now, there is a pressing question regarding the most detrimental phenomenon associated with foreign debt that fuels the raging fire. In times of scant foreign exchange reserves, managing debt servicing and debt maturity becomes a critical aspect of foreign debt that can trigger a harmful economic cycle.
The scant foreign exchange reserves are a consequence of the average annual 2.3 percent current account deficit as a percentage of GDP over the last decade. Pakistan has a long tradition of higher current account deficits and relying on foreign debt as a last resort to facilitate imports when foreign exchange falls short.
Pakistan must focus on boosting foreign exchange reserves through the implementation of various policy measures aimed at managing the flow of foreign currency. It is inescapable to address the trade deficit by bringing imports in line with exports, which currently surpass them by more than twice the amount. In addition, a strategic mix of exports, remittances, and FDI is crucial for addressing the need for foreign currency outflow and bolstering the foreign exchange reserves. Having higher forex reserves is crucial for maintaining stability in the forex market and making it easier to repay external debts. Pakistan could boost foreign currency inflow through FDI by emphasizing a stable currency, political stability, rule of law, business-friendly environment, and low cost of doing business
In 2023, Pakistan managed its current account deficit to a mere $2.2 billion, which was 0.5 percent of its GDP, compared to $17.5 billion, which was 4.1 percebt of its GDP, in 2022. While in 2024, it is projected that the current account deficit will clock in at 1 percent of GDP. Pakistan used to struggle with a shortage of foreign exchange reserves to cover the current account deficit. Currently, forex reserves are under pressure due to a substantial amount of debt maturing in 2024, overshadowing the current account deficit.
The landscape of Pakistan’s external servicing– repayment of interest and principal debt– depicts a three-fold increment from $6 billion per annum to $18 billion over the last decade. The momentum of principal and interest payments on foreign debt is increasing exponentially.
The mounting external servicing asserts pressure on the foreign exchange reserves, which are already strained by ongoing current account deficits. The current level of foreign exchange reserves held by the State Bank of Pakistan stands at $9.1 billion as of 3 May 2024. This amount is equal to one and a half months of import bills, which falls below the recommended three-month threshold for import bills.
The inflow of foreign currency from remittances, exports, and foreign direct investment (FDI) will remain stagnant and fail to paint a satisfactory picture in the current fiscal year. Nevertheless, the outflow concerning imports is likely to stay static or may even increase slightly. Considering the constant movement of foreign currency in and out, the current account is unlikely to contribute to the current supply of forex reserves.
Pakistan requires $24.965 billion (7.1 percent of GDP) this fiscal year, the highest ever, in foreign currency to fix its external servicing and current account deficit, according to the projection of the International Monetary Fund (IMF).
Securing the necessary amount of foreign currency is essential for stability in the forex market. Insufficient external financing could further worsen the already dire economic indicators. In particular, it could exacerbate the exchange rate, inflation, economic growth, unemployment, and economic outlook.
In 2023, the economy of Pakistan was severely impacted by political instability, resulting in a 38 percent inflation rate, 700,000 jobs lost, the closure of 1600 textile factories, a 20 percent exchange rate depreciation, and a policy rate of 22 percent. These indicators are still in a fragile state with no sign of recovery. Improper management of foreign debt could exacerbate these indicators and perpetuate an ongoing economic crisis.
Managing forex reserves will be a crucial challenge for the newly elected government of Pakistan due to inherited financial mismanagement of the previous administration. The forex market’s stability is crucial as it is intricately linked to the decision-making processes of households, businesses, and the government, ultimately influencing Pakistan’s economic landscape.
Pakistan must focus on boosting foreign exchange reserves through the implementation of various policy measures aimed at managing the flow of foreign currency. It is inescapable to address the trade deficit by bringing imports in line with exports, which currently surpass them by more than twice the amount. In addition, a strategic mix of exports, remittances, and FDI is crucial for addressing the need for foreign currency outflow and bolstering the foreign exchange reserves. Having higher forex reserves is crucial for maintaining stability in the forex market and making it easier to repay external debts. Pakistan could boost foreign currency inflow through FDI by emphasizing a stable currency, political stability, rule of law, business-friendly environment, and low cost of doing business.
