Pakistan's $300 billion economy is approaching the doldrums after a period of strong growth. In the 2018-19 fiscal year that ended in June, economic expansion is forecast to have cooled to 3.3 percent, down from a 13-year high of 5.5 percent set the previous fiscal year. For Prime Minister Imran Khan, managing the economy has proved a major challenge since his Pakistan Tehreek-e-Insaaf took the helm in a coalition government in August 2018. To rein in the country's unsustainable trade and fiscal deficits, the government has hiked interest rates, allowing the Pakistani rupee to weaken, and cut public spending — measures that initiated a slowdown by dampening growth in the consumption-driven economy. The slowdown will make for volatile politics in Pakistan in the short term as the opposition tries to exploit the economic pain.
Pakistan's economy is characterized by frequent boom-and-bust cycles. After the latest spell of growth, rising fiscal and trade deficits are now forcing the government to cool the demand for imports and implement austerity measures. Implementing these measures will slow growth, creating opportunities for the political opposition. But even if protests grow, the army has the ability to silence dissent. Still, Prime Minister Imran Khan and the army want to avoid anything that could hurt business confidence in Pakistan, especially given the country's impending economic slowdown.
Two Widening Deficits
Pakistan's economic malaise stems from its dependence on imports. The country lacks a competitive export basket of higher value-added items, with cotton products, leather and rice accounting for 69 percent of exports. In the other direction, Pakistan imports large quantities of machinery, electronics, metals and oil — its most expensive import — which together account for half of Pakistan's $60 billion in annual imports. As a result, Pakistan has run a persistent trade deficit, which totaled $36 billion in 2018.
Paying for this deficit has proved challenging. The State Bank of Pakistan has tapped into its foreign exchange reserves for dollars, a preferred currency for international trade. Remittances and foreign direct investment — two additional sources of dollars — have not stopped the gradual erosion in the central bank's reserves, which totaled just $7.8 billion as of June 3. This falls below a threshold recommended by the International Monetary Fund, which advises countries to maintain enough foreign exchange reserves to pay for three months of imports. The lack of foreign exchange reserves has resulted in Pakistan's latest balance of payments crisis, complicating its ability to pay for imports and service its debts in dollars.
And the trade deficit isn't the only deficit Khan must contend with. The government's fiscal deficit, or the gap between revenues and expenses, has reached an unsustainable level of 6.5 percent of gross domestic product, a five-year high. Interest payments on loans to the government and defense spending fueled much of the increase in expenditures. Making matters worse, government revenues remained flat: Though tax revenue grew by 2.8 percent, nontax revenues fell by 16.7 percent, thus failing to offset the increased expenditures. To pay for this deficit, Islamabad borrowed $12 billion from a combination of foreign and domestic sources in the 2018-19 fiscal year. Accumulating debt to service existing debts, of course, will increase interest payments — still the biggest budgetary expense — down the road in a vicious cycle that will increasingly divert public funds from elsewhere.
The Government Embraces Austerity
Reducing the country's trade and fiscal deficits will remain Khan's overriding domestic challenge in the months ahead. In May, his administration clinched, in principle, a $6 billion loan with the IMF to shore up its dwindling foreign exchange reserves. The agreement, Pakistan's third with the IMF since 2008, followed monthslong talks during which Khan sacked his finance minister and central bank chief, replacing them with technocrats more amenable to implementing the politically challenging measures required under the terms of the IMF loan.
On the monetary policy front, those measures — which have included the State Bank of Pakistan hiking interest rates by 150 basis to 12.25 percent to combat inflation, and letting the rupee weaken by 11 percent since May to cool demand for imports — have weakened the purchasing power of the Pakistani people and businesses, dampening growth in an economy fueled by consumption.
Pakistan's economy will enter a protracted slowdown as consumption drops and unemployment rises.
On the fiscal policy front, Khan has made generating government revenue a centerpiece of his recently unveiled $45 billion budget. To raise revenue, his government has set an ambitious target of raising $37 billion in taxes in the next fiscal year through increased levies on income, electricity, gasoline and sugar, along with the privatization of state-owned companies. The administration also aims to cut subsidies and development spending.
An Opportunity for the Opposition
As austerity measures dampen demand for imports, raise the cost of capital and allow the rupee to weaken in the months ahead, Pakistan's economy will enter a protracted slowdown as consumption drops and unemployment rises. A drop in Islamabad's investment in development projects, a key source of growth in the industrial sector that also boosts the economy's large service sector, will aggravate the slowdown.
And this, in turn, will create opportunities for the opposition. Corruption scandals have hobbled the two main opposition parties, the Pakistan Muslim League-Nawaz (PML-N) and the Pakistan People's Party (PPP), in recent years. Former Prime Minister Nawaz Sharif of the PML-N and former President Asif Ali Zardari of the PPP are both ensnared in graft cases. The Pakistani Supreme Court removed Sharif from office in 2017, and he is currently serving a seven-year jail sentence. Zardari, meanwhile, was arrested June 10 on money laundering charges. Now, the PML-N and the PPP can seek to shift attention from corruption to anger at Khan over the economic slowdown.
Though the two opposition parties have historically been rivals, they are now exploring a tactical alliance over the economy. Sharif's daughter, PML-N Vice President Maryam Nawaz, and Zardari's son, PPP Chairman Bilawal Bhutto Zardari, have opposed Khan's budget in the parliament, though the prime minister's coalition scored enough votes to pass the budget in the National Assembly on June 28. The two also attended a conference the week of June 23 to sketch out a joint strategy for opposing Khan, which could involve launching mass protests. (Khan is no stranger to this tactic: He personally led a mass march to Islamabad in summer 2014 to force Sharif from office.)
These parties' efforts will run up against the powerful Pakistani army. The two main opposition parties consider Khan's legitimacy suspect due to his cozy relationship with the army, which many allege helped him take office. Doubtless, the army will play a key role behind the scenes in ensuring Khan's political survival as the world's sixth-most populous country weathers its latest economic bust.