A crisis in the making

Although the escalating geopolitical tension between Russia and Ukraine is thousands of miles away from Pakistan, its economic fallout has started spilling into Pakistan as well.

While Pakistan is on the path of recovery from the Covid-19 pandemic, the ongoing geopolitical tensions are likely to result in a general price increase, deteriorating current account and fiscal balances, and stifling economic growth.

Historically, Pakistan has had modest bilateral economic ties with both Russia and Ukraine. In 2021, the value of trade with Russia was $711 million – including $537 million in imports from Russia. Similarly, bilateral trade between Pakistan and Ukraine was valued at $800 million in 2021, with Pakistan receiving $739 million in imports. Consequently, Pakistan’s wheat import will be directly affected by the crisis since it arrives from Ukraine and accounted for 39 percent of the country’s total imported wheat in the previous fiscal year. However, the indirect cost of the crisis in terms of global energy and commodities supply chains is expected to outweigh Pakistan’s direct trade losses with Russia and Ukraine.

The conflict has already shaken economies across the world in numerous ways. For instance, sanctions imposed by the US and Europe on Russia are likely to disrupt energy supplies from the world’s largest supplier. A $10-20 per barrel increase in oil prices over a few quarters is projected to deplete Pakistan’s national reserves by $1-2 billion, thus further shrinking the country’s purchasing power.

Inflation in Pakistan has already surpassed a two-year high of around 10 percent, placing a strain on the government, which is fighting multiple economic and social fronts. This will further aggravate the inflationary pressure and hit the consumers badly, resulting in the rise of poverty and discontinuity in economic policies.

Inflationary pressure can lead to a wage-price spiral, in which individuals demand greater wages to meet rising living costs, inducing businesses to raise prices across the board to cover extra costs. From a macroeconomic perspective, the central bank is under pressure to raise interest rates even higher. This will exacerbate economic instability, particularly if inflation continues to rise and the central bank responds by drastically raising interest rates.

Government expenditures may reduce in real terms as a result of the price hike and disruption in the food value chain, decreasing the number of government services and development spree. Furthermore, if businesses are apprehensive that they will not be able to raise prices enough to compensate for higher wages, they may be compelled to lay off their workforce, resulting in increased unemployment. A prolonged crisis poses a greater danger of pushing the economy into stagflation, which is characterised as high inflation combined with slow economic growth.

The government must take measures to protect the economy from the potential effects of the current Russia-Ukraine conflict. The economy is already under strain as a result of the government’s recent agreement with the IMF to impose harsh conditions such as the elimination of tax exemptions, an increase in the petroleum levy on fuel and electricity prices, and the removal of fiscal and monetary stimulus for the industry.

A discourse with stakeholders and opinion leaders in Pakistan is required to devise a comprehensive policy to avert the likely consequences of the looming crisis.

The writer is an assistant professor at Abdul Wali Khan University, Mardan. He can be reached at: kamal@awkum.edu.pk