Across the world, many lower- and middle-income countries (LMICs) are struggling with balance of payments difficulties that are undermining their ability to service their external debt. The shocks delivered by the COVID pandemic and the speculation-induced spike in fuel and food prices triggered by the war in Ukraine magnified chronic deficits.
Dozens of countries are overcome by debt stress and struggling to avoid default, and a few such as Zambia, Sri Lanka, and Ghana have already defaulted on their external debt. This has not only worsened economic conditions, especially for the poor in these countries, but undermined their ability to address problems associated with crises of global dimensions, such as climate change. As recognised by the international community when committing to the Sustainable Development Goals, these problems are not specific to less developed countries but affect all nations. So, resolving the debt problem is in the interest of all nations. Yet action is falling short.
“The policies the IMF prescribes when it is approached for balance of payments support in situations of stress contribute to worsening the situation in “assisted” countries. ”
Part of the problem is that the principal player in debt resolution negotiations has a rule book that is not fit for the purpose. It has been clear for some time that the policies the IMF prescribes when it is approached for balance of payments support in situations of stress not only fail but contribute to worsening the situation in “assisted” countries.
Moreover, even after the realisation that sometimes there is no option but to write off debt, which led up to the Heavily Indebted Poor Countries and the Multilateral Debt Relief initiatives, the policies recommended found these countries sliding back into unsustainable indebtedness. Yet there are no signs of change in the conditions imposed by the IMF as ongoing negotiations with Pakistan, for example, are making clear.
Three common features
In all cases of debt stress, differences notwithstanding, there are three common features. First, both the accumulation of debt and the inability to service that debt are fundamentally, though not solely, the result of a chronic balance of payments weakness resulting from an inadequate diversification of economic structures. This increases a country’s dependence on imports, including of many essentials. It also limits the ability of the country to earn foreign exchange through exports.
Second, multiple instances of IMF engagement consisting of limited financing support provided in return for adherence to policy conditionalities have not resolved these difficulties. With no evidence of returns and with economic conditions deteriorating, countries retreat from such policies at the first opportunity. Third, given this persistent vulnerability, any shock, let alone severe ones like the pandemic, sees a sharp deterioration of the balance of payments and a spike in external debt.
The impasse in Pakistan over the effort to resolve a debt crisis with devastating implications for livelihoods and lives needs to be assessed against this background. Besides the COVID shock and the rise in the prices of food and fuel, Pakistan is dealing with the fallout of the devastating floods that affected a third of the country last year, took the lives around 1,700 people, and afflicted huge economic damage. Growth and exports collapsed while import dependence only increased.
Like many other LMICs, Pakistan has suffered from chronic trade and current account deficits for a long time. Exports have been sluggish for reasons external and domestic, whereas imports have risen, partly because of a rising oil import bill and partly because growth rode on waves of import-intensive spending. The resulting deficit was financed substantially with external debt, which rose from $60 billion to $108 billion between 2013 and 2018, according to figures from the World Bank.
Then, special factors such as the pandemic, the fallout of the Ukraine war, and floods worsened the situation. The trade deficit, having fallen from $27 billion in 2019 to $24 billion in 2020, rose to $47 billion in 2021. It was on top of this that the speculation-induced increase in the prices of food and fuel were felt. As a result, foreign currency reserves were down to as little as $3 billion, adequate to finance less than a month of imports. The foreign exchange crunch forced the government to clamp down on imports. The country has had to ration fuel, leading to widespread electricity shutdowns. Reductions in imports of food and raw materials resulted in shortages and stoked inflation, which, worsened by a depreciating rupee and hikes in the prices of diesel and gas, is running at close to 30 per cent, the highest in five decades.
Deep and present crisis
It is in these circumstances that the country has since late last year been engaged in desperate efforts to win IMF support in the form of a post-review release of one more tranche of $1.1 billion of a $6.5 billion loan programme that was launched in 2019. That release, linked to adopting wide-ranging austerity measures, was held up because the IMF, in its “ninth review”, was not satisfied with Pakistan’s adherence to conditions set for the loan. The money may not be much but is crucial immediate relief since the crisis is current and deep. But the IMF delegation that visited the country to undertake the review left in February without issuing a statement.
This rebuff occurred even though over the last few months the Pakistan government has been announcing policies varying from enhanced imposts on fuel consumption to reductions in subsidies that were clearly meant to appease IMF bureaucrats.
The most recent such manoeuvre was a sharp increase in gas prices by up to 34 per cent for different categories of commercial users. The IMF is reportedly seeking much more, including a transition to a market-determined exchange rate that could precipitate a crash in the currency, more reduction in what it describes as “untargeted” subsidies, and further increases in energy prices. It also wants bilateral creditors, especially China, to provide additional support to ensure that the country can avoid default. “The timely and decisive implementation of these policies along with resolute financial support from official partners are critical for Pakistan to successfully regain macroeconomic stability and advance its sustainable development,” the IMF staff declared in a statement.
13 IMF programmes
Given the economic and political circumstances in the country, the government is finding it difficult to go further than it has. In early February, Prime Minister Shehbaz Sharif was reported as saying that the IMF’s demands were “beyond imagination” and it was “giving a tough time to the Finance Minister and his team”.
Past experience suggests that the IMF rarely turns its back on Pakistan. The country received its first Extended Fund Facility loan from the IMF in 1988. Since then, it has been under 13 IMF programmes. Pakistan remained a favoured borrower even though during almost all these programmes policymakers failed to deliver on the targets set, especially with respect to reducing the fiscal deficit.
Twelve out of these 13 programmes were stalled midway. Yet each time, after a short gap, when Pakistan needed more funding to stave off balance of payments difficulties, the IMF returned to negotiate a new facility.
There are, however, many factors that make the going tough for the country this time. First, with the US having washed its hands of Afghanistan and walked out, handing the country over to the Taliban, the strategic importance of Pakistan is less than before. More so because of Pakistan’s proximity to China and because India is increasingly serving as the principal South Asian ally in the US effort to contain China.
So, pressure from the US on the IMF has possibly weakened considerably. This connects to the second factor delaying the IMF agreement, which is an effort to make up for the relaxation of loan conditionalities for Pakistan in the past. Not facing the same pressure to be lenient, the IMF, in the context of a severe crisis in Pakistan, may be pushing to get the government to implement measures it had sidestepped in the past, especially on the energy and fiscal fronts.
Finally, the IMF, the US, and its allies have been vocal that “their money” should not be used to repay loans due to China or finance imports from that country since a significant proportion of both that debt and those imports are linked to Belt and Road Initiative projects that strengthen China’s geopolitical position in the region. Of the $130 billion of outstanding external debt at the end of 2021, $95 billion was public or publicly guaranteed debt. Of that, $27 billion, or more than 28 per cent, was owed to China. Similarly, 28 per cent of Pakistan’s imports in 2019 came from China compared with just 5 per cent from the US.
Other funding sources
Pakistan has other funding sources. According to reports, the United Arab Emirates has agreed to loans of $3 billion, while Saudi Arabia is considering an investment of nearly $10 billion. But even that may not be enough. In late January, the Governor of Pakistan’s central bank said the country had repaid $15 billion of the $23 billion in loans due in the fiscal ending June 2023 and that of the remaining $8 billion, $3 billion would be rolled over. But all that seems far too ambitious.
For the IMF to push for austerity measures in these circumstances, involving reduced subsidies and a sharp curtailment of government expenditure, in return for meagre assistance is brutal to say the least. Especially since such measures are no solution.
With its GDP having shrunk after the floods, Pakistan cannot afford further contraction of output and employment. And there is no reason that will revive exports and improve the balance of payments situation. Pakistan is likely to be the next South Asian country, after Sri Lanka, to default on external debt payments. The international community’s faith in a reformed IMF being an instrument for global governance in times of crisis seems completely misplaced.
C.P. Chandrasekhar taught for more than three decades at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi. He is currently Senior Research Fellow at the Political Economy Research Institute, University of Massachusetts Amherst, US.
- Across the world, many countries are struggling with balance of payments difficulties. The shocks delivered by the COVID pandemic and the speculation-induced spike in fuel and food prices triggered by the war in Ukraine magnified chronic trade and current account deficits
- The economic conditions in these countries have worsened, especially for the poor.
- Even though it is known that the debt problems are not specific to less developed countries but affect all nations, little action has been taken to resolve them.
- The IMF, the principal player in debt resolution negotiations, is part of the problem. Its policy prescriptions in situations of stress not only fail but contribute to worsening the situation in “assisted” countries even when it realises there is no option but to write off the debt. This is clear from the conditions it is imposing on Pakistan in ongoing negotiations.
- The country is dealing with the COVID shock, the rise in the prices of food and fuel, and the fallout of last year’s devastating floods. Growth and exports have collapsed while import dependence has only increased.
- Since late last year, Pakistan has been engaged in desperate efforts to win IMF support to release one more tranche of $1.1 billion of a $6.5 billion loan programme that was launched in 2019. The release was held up because the IMF was not satisfied with Pakistan’s adherence to conditions set for the loan.
- Past experience suggests that the IMF rarely turns its back on Pakistan, but the situation is a bit different today for the following reasons: (1) the country has less strategic importance to the US after the latter’s withdrawal from Afghanistan; (2) Pakistan’s proximity to China; (3) India is increasingly serving as the principal South Asian ally in the US effort to contain China ; and (4) the IMF, the US, and its allies do not want “their money” to be used to repay loans Pakistan owes China.
- But for the IMF to push for austerity measures when Pakistan is in dire economic straits in return for meagre assistance that will ultimately not solve the country’s problems is brutal say the least.