Causes of economic slowdown

The impact of contractionary measures has started taking its toll on the economy

Causes of economic slowdown


fter assuming power in April 2022, the coalition government of the Pakistan Democratic Movement has taken a number of measures to slow down economic activity in the country. Aimed at “cooling down” the unsustainable economic growth, these steps presumably overturn unwise policies and end imprudent actions. Unfunded subsidies by the previous coalition regime, led by the Pakistan Tehreek-i-Insaf, have rendered the economic outlook bleak.

The national economy is on the verge of a collapse; the risk on external front is much greater and may not be mitigated in the near future. Owing to aggressive corrective measures, the immediate threat of economic breakdown seems averted.

During the last seven decades, we have seen several cycles of boom and bust. Since the 1960s our economy has been growing at a reasonable pace. However, after brief sprints of progress, pressures on the external front resurfaces at alarming levels. To counter it, the overall economic activity level is deliberately slowed down through contractionary/ austerity measures. This recurrent pattern is indicative of the fact that Pakistan’s growth is heavily import-based.

In pursuing high economic growth, we end up having an unsustainable import bill, resulting in monstrous current account deficits. This and other deficits, most notably fiscal and trade, were bridged in the past through borrowing — internal and external. The obvious result is an accumulation of huge, unsustainable external debt that is now over $130 billion.

The forcibly suppressed activity level may help bring down the trade and current account deficits. However, the fiscal constraints at this time do not allow us to repay debts that will be due in the coming days. Unless requests to the lenders to reschedule or rollover are accepted, we risk a default.

Our foreign exchange reserves have been constantly depleting for the last few years. These dwindled down to $11.5 billion in December 2022. The main reason for this was reckless borrowing by the PTI government during its tenure (August 18, 2018 to April 5, 2022). The government frantically secured foreign debts from multilateral partners, commercial banks and through issuance of debt instruments – raising the country’s debt profile by around $35 billion.

It is pertinent to mention that during the last eight months of the PTI government, i.e., July 2021 to March 2022, foreign exchange reserves declined from $27.067 billion to $17.426 billion — a monthly reduction of nearly $1.205 billion. During the nine months rule of PDM government, foreign exchange reserves have gone down by another $6 billion (including two major payments, against bonds and to UAE banks) from March 31, 2022 to December 31, 2022, registering an average monthly reduction of $655 million.

Depletion of foreign exchange reserves is currently being resisted through a curtailment of imports, imposition of a cash margin requirement, pre-approval requirements for letters of credit and other administrative measures. Moreover, in an effort to resume the Extended Funded Facility programme of the International Monetary Fund, the government has revoked all subsidies on fuel and energy. This has triggered high inflation.

Our foreign exchange reserves have been depleting for the last few years. These dwindled down to $11.5 billion in December 2022. The main reason for this was reckless borrowing by the PTI government during its tenure.

These steps have been taken together with constant upward revision in policy rate (presently 16 percent) by the State Bank of Pakistan (SBP). Over a period of almost 15 months, the policy rate has more than doubled from seven percent in September 2021 to sixteen percent in December 2022. The exuberant increase in policy rate has virtually closed all avenues of growth and business expansion in the country. Businesses are finding it difficult to bridge even their working capital requirements.

Another challenge faced by the government is a constant reduction in exports and foreign remittances. These two work as the first line of defence to curtail the current account deficit. After taking these into account, the remaining deficit has always been filled through borrowing. Due to a high rate of inflation of (over 20 percent), increased cost of doing business and an unstable exchange rate, our exports and remittances are declining.

Exports declined to $2.3 billion in December 2022, 16.6 percent lower than $2.7 billion in December 2021. For the six months period, i.e., July 2022 to December 2022, overall exports lingered at $14.249 billion, approximately 5.8 percent lower than $15.125 during the corresponding period last year. Similarly, based on data available to date, remittances during July-November 2022 stood at $12 billion, 9.6 percent lower than $13.3 billion during July-November 2021.

The significant reduction in remittances is directly attributable to administrative failure and imprudent policies of the PDM government. The interbank exchange rate (currently $1: Rs 227) is not reflective of open market dynamics where an American dollar fetches around Rs 260. This difference of around 15 percent is making official channels unattractive. Resultantly, an informal open exchange market is flourishing.

Apart from economic challenges on the external and internal fronts, Pakistan witnessed catastrophic flash floods in 2022 after unprecedented rains due to global climatic changes for which it bears no responsibility. The floods caused over $30 billion losses and disrupted the economic activities in agriculture and livestock sectors etc, besides damaging infrastructure.

At the start of Quarter II of FY23 SBP estimated that GDP growth could come down to around 2 percent in FY23 — the initial growth forecast of 3-4 percent before the floods is now irrelevant. It is heartening to note that the international community has recognised its responsibility and pledged nearly $10 billion for the next three years at the recently concluded International Conference on Climate Resilient Pakistan in Geneva.

The impact of contractionary measures has started taking its toll on the economy — confirmed by statistics issued by the Ministry of Finance in its Economic Outlook for December 2022. The growth of large-scale manufacturing on year-on-year (YoY) basis plunged by 7.7 percent in October 2022 — during July-October of FY23 it witnessed a contraction of 2.9 percent. The fiscal deficit during July-October 2022 stood at 1.5 percent of GDP (Rs 1.226 billion) as compared to 0.9 percent of GDP (Rs 587 billion) last year. During July-October 2022, the primary balance posted a surplus of Rs 136 billion (0.2 percent of GDP) against the surplus of Rs 206 billion (0.3 percent of the GDP) last year.

It is feared that the deteriorating trend will persist unless the government comes up with a serious reform agenda that can help find a long-term sustainable solution for the revival and survival of the economy. In this regard, resumption of the IMF programme and completion of outstanding tasks are critical factors. The finance minister claims to be committed to bringing the IMF’s EFF programme back on track. However, it appears, that he is looking forward to an emphatic positive response from the IMF towards the fiscal needs of Pakistan as it is struggling hard to cope with the after effects of the 2022 disastrous floods.

Dr Ikramul Haq, an advocate of Supreme Court and writer, is adjunct faculty at Lahore University of Management Sciences (LUMS) and a member of the Advisory Board and Visiting Senior Fellow of Pakistan Institute of Development Economics (PIDE).

Abdul Rauf Shakoori is a corporate lawyer based in the USA and an expert in white collar crimes and sanctions compliance. They have recently co-authored a book, Pakistan Tackling FATF: Challenges and Solutions with Huzaima Bukhari.

Causes of economic slowdown