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Wednesday, July 17, 2024

Pakistan and the incoming Sovereign Default

Pakistan has so far managed to stave off riots and repay creditors, avoiding an economic meltdown like that seen in Sri Lanka. Still, Prime Minister Shahbaz Sharif’s coalition government, which took over in April 2022, is grappling with multiple political and economic crises.

Pakistan’s sovereign default is inevitable unless a profound directional change is adopted as soon as possible. The recent decline in the rupee’s value despite the IMF agreement equates to the writing on the wall that things have arrived at the point of no return. Changing a finance minister or even the Prime minister will not yield any dividends, writes a faculty at Brown University.

Constant Pressure on the rupee is primarily due to its loss of purchasing power in addition to the current account deficit. In the last year, all global currencies have collapsed against the US dollar except the Russian rouble, which has surprisingly gained in value.

By directional change, the country must face the reality that it can no longer live on loans and handouts and be entirely dependent on imports.

Read more: Reviewing legal framework on control of Narcotics substances in Pakistan

Understanding the matter better

When society is not creating value in this global economy, the rupee is bound to lose its purchasing power. Any artificial attempts or currency manipulations are likely to be attempted by the incumbent finance minister, but they are bound to fail, unfortunately.

Pakistan’s poor exports and mounting imports need no explanation. But what is frightening is that no serious effort is made for this paradigm shift. For example, even though petroleum products are one of the most important items on our import bill. Yet, no credible or intelligent efforts are made to address this part of the import bill. Our auto policy is indicative of this poor decision-making.

While the world is going through the electric vehicle revolution, Pakistan recently increased its duty on electric vehicles. Instead, Pakistan should have been begging all major electric vehicle manufacturers to build their products in Pakistan and exploit this market of 220 million people.

Policymakers should have sought this on a war-like footing

Any major electrical car producer coming to Pakistan would have created thousands of jobs for the local economy, resulting in some skills transfer, provided relief to the people with exorbitant petrol prices, and at the same time, addressed our import bill. Such manufacturers should have been given deals they can not refuse if the country is serious about addressing this. Electric vehicles will not only reduce our import bill, but they will also help the worsening climate and the air we breathe.

Electrical buses, an operational railway, or other public transport systems would have helped this further. Similarly, the goods transport system entirely reliant on fossil fuels is highly unintelligent and needs to run on alternative energy sources.

Looking at the energy sector will reveal that high energy bills have recently hit the Pakistani masses. However, examining this further will reveal that Pakistan’s energy mix is still predominantly reliant on fossil fuels, some hydropower, and some renewables.

Fossil fuel run IPP (Independent Power Producers) with contracts with guaranteed returns in USD of up to 17% can only be termed suicidal.

Read more: US encourages for productive Pakistan-India relations

The country cannot simply afford this expensive electricity and requires cheap electricity. This unaffordability will result in slowly of economic activity, which is counterproductive.

The country should urgently build dams and invest heavily in solar or nuclear energy on an emergency basis. Instead, contracts on deferred payments are sought from Qatar or other oil-rich countries with a begging bowl.

Lack of concerns and its consequences

Another example of pure insanity is the lack of productivity in our agricultural sector, making Pakistan food insecure. Historically, our farmers are not as productive as their global peers. This is multifactorial; lack of research, investment in this sector, exploitation of poor farmers, and brutal conversion of agricultural land into housing societies have disenfranchised the struggling farmer. As a result, our food reserves are alarmingly low compared to our neighbors, e.g., India.

Indian farmers are much more productive than their Pakistani counterparts. Rough estimates suggest Pakistan spends almost $10 billion on the import of food items alone. Pakistan’s feudal class is not interested in this sector’s scientific transformation. They are happy to exploit the poor peasants working on their lands and suck the last drop of their blood. The majority of Politicians are feudal landlords, and they will block any transformation of this sector due to their illegitimate self-interests. The politicization of Pakistan’s sugar industry, political allocation of permits to install a sugar mill, and corrupt subsidies require no explanation. Pakistan is even spending $billions on importing edible oil, which is shameful for an agricultural economy. Similarly, value addition in our textile sector is minimal. Pakistan imports tea, lentils, wheat, and rice.

Read more: Pakistan going through toxic times -Part 1

Land reforms, a scientific transformation of the agricultural sector, and a lack of investment are not even on the agenda. Similarly, no water reservoirs have been built over the decades, which are required for our farmers and to avoid catastrophic floods. Recent biblical floods are a reminder of our failure as a society. Yet, despite these, no political discourse exists on building dams and reservoirs today.

Across the border, Nehru laid the foundations for India’s scientific and industrial base. Pakistan failed to create any industrial base. Pakistan imports almost all medicinal products, machinery, and highly skilled services for most sectors. There has been no effective policy on skill transfer, and foreign direct investments are simply non-existent.

Pakistani Policy makers have failed to learn the fundamental truth that the vast majority of foreign direct investments in emerging markets have been by the private sector. It is not the IMF, World Bank, or Asian Development bank that has invested heavily in emerging markets. So, for example, when Amazon decides to go to India, it directly benefits the Indian economy and has not been directed by the IMF to open shops in India.

Foreign direct investments by the private sector depend on political stability with clear policies and contractual enforcement by the dispute resolution authorities, e.g., law enforcement or the judiciary. Unfortunately, political instability due to constant political interference has continued for 75 years. In civil justice, Pakistan ranked 124 out of 139 in 2021. Therefore, no significant foreign direct investment will happen in such a climate, regardless of whether PTI or PML-N is in power.

Now coming back to the rupee’s decline, Pakistani Policy makers must analyze why the Russian rouble has gained against the dollar compared to other currencies. The Russian rouble is hedged with Russian oil, gas, and wheat commodities, hence gaining against the USD.

Read more: Pakistan going through toxic times – Part 2

Unless the rupee is hedged against certain commodities or value-added products, no amount of IMF dollars can stop its decline. The only thing that can hedge the rupee in the short term is agricultural commodities. Declaring an agricultural emergency and bumper crops can somewhat help the rupee gain some strength. Everything else will take much longer.

Hence, Pakistani imports will continue to rise in 2023, and the rupee will continue to devalue. Therefore, no one can prevent Pakistan from defaulting unless there is a directional change in all major sectors for which there is no evidence currently.

The current economic architecture is unsustainable and has arrived at its expiry date. But unfortunately, continued poor decision-making by inadequate minds at the very top, regardless of who is in power, might fast forward our journey into sovereign default.

Chickens have come home to roost.


The author is a graduate of the University of Oxford’s Said Business School and currently works as Faculty at Brown University in the United States. The views expressed in the article are the author’s own and do not necessarily reflect the editorial policy of Global Village Space.