Understanding Pakistan’s Polycrisis - And Navigating a Path Forward

This study entitled ‘Understanding Pakistan’s Polycrisis – And Navigating a Path Forward’ has been authored by Sakib Sherani for The Pakistan Business Council (PBC). The study discusses the economic crisis Pakistan is going through and proposes potential ‘breakout’ conditions that can be adopted to achieve sustained economic development and national prosperity.

Pakistan is in the vortex of yet another economic crisis – its 13th since 1988. However, this one is unprecedented in its severity as well as its complexity, since the economic crisis has emanated from a confluence of multiple shocks. A substantial terms of trade shock coincided with the impact of a “sudden stop” in external capital availability caused by the aggressive monetary tightening by the US Federal Reserve. In addition, the country is now in a full blown public debt crisis, with a need for sovereign debt restructuring or re-profiling.

The crisis could envelope the country’s banking sector at some later stage – despite substantial capital and liquidity buffers at present. With widespread industry and business closures, non-performing loans are growing, and are expected to spike. More potently, the system’s largest borrower is under increasing fiscal duress, with its debt overhang now consuming well over 100 per cent of net revenue in servicing costs. To complicate matters further, sovereign debt could require restructuring that is likely to include domestic public debt – with bank lending the largest component. A significant haircut for banks could be inevitable under this scenario – though this could occur over the course of 2024 or in 2025, or be mitigated if the route of debt re-profiling is taken. In either case, enhanced surveillance and monitoring by the central bank can be important risk mitigation instruments.

The sense of a polycrisis is accentuated by the fact that the country is facing a political and constitutional crisis since April 2022. Political uncertainty and institutional gridlock are complicating policy responses and “whole-of-nation” approaches that are required for an early resolution.

Concurrently, the prognosis for the global economy is turning gloomy. The IMF has cautioned that “the fog around the world economic outlook has thickened.” The World Bank has issued a much starker warning. It believes the world economy could be on the brink of a “lost decade”.

In this complex and challenging scenario, the prospects for Pakistan’s economy for the next 3 to 4 years appear less-than-sanguine, despite the relative optimism surrounding the recent securing of a nine month Stand-By Arrangement (SBA) from the IMF.

While the near term risk of a sovereign default appears to have been averted in the interim, contingent on continued implementation of IMF conditionality, stabilisation and austerity policies will need to remain in place beyond the current SBA as the country undertakes a debt workout, one that could include domestic debt. Economic growth will remain suppressed and financial conditions restrictive, while the overall business environment will be challenging, especially for the formal sector.

Macroeconomic risks are likely to remain elevated, which could be compounded by the risk of political instability. Climate-related shocks are grey rhinos (slow-moving, probable risks with high impacts) that can precipitate at any time over the forecast horizon. Vulnerability to external shocks will remain high until ‘break out’ conditions prevail.

Potential ‘break out’ conditions include: a firm resolution of the current political deadlock, holding of free and fair elections together with an orderly and timely transition to a government with a clear “reformist” agenda, political stability, a benign global economic environment, timely as well as sustained availability of adequate external financing and support, including a successor IMF program with higher quota access and greater emphasis on structural reform, a quick and orderly sovereign debt re-profiling, and reverse capital flight.
Each of these conditions is necessary though not sufficient on its own. Ultimately, the surest guarantee of finding a path to recovery and durable prosperity is for all stakeholders to view the current crisis as an opportunity for wide-ranging, deep and credible reform. One of the principal goals should be to ensure that the burden of adjustment does not fall disproportionately on the documented, tax-paying formal sector as in the past – or on vulnerable segments of society less able to pay. Instead, the reform effort should focus on formalising the country’s outsized informal sector, which will not only boost tax revenue but also productivity and private investment, including FDI. This is the surest path to sustained economic development and national prosperity.