Pakistan caught in debt trap

Pakistan’s debt crisis, further aggravated by the COVID-19 pandemic, is the result of not only its fiscal profligacy but also the supply side debt push arising from the competing security ambitions of the United States and China.

Pakistani protesters carry anti-International Monetary Fund (IMF) placards at a demonstration in Islamabad on November 11, 2008. Ever since receiving its first Extended Fund Facility (EFF) loan in 1988, and notwithstanding breaches of conditionality, Pakistan has been rewarded repeatedly with new loans by the IMF.

T he COVID-19 pandemic and its after-effects have worsened Pakistan’s external debt problem. The nature of the problem is one typical of a country trapped in debt. While the burden of legacy debt is large, keeping the economy going requires borrowing more. Being on that trajectory implies that the foreign exchange required to meet interest and amortisation payments on past debt is large and rising. So additional borrowing must also cover the cost of servicing past debt. The result is a runaway increase in indebtedness until the tap runs dry and a crisis ensues. That has not yet happened, and Pakistan appears to be still afloat. But the ability to stay afloat seems to be part of the problem.

Pakistan’s total public debt stood at 87 per cent of the gross domestic product (GDP) and external debts and liabilities stood at 45 per cent of the GDP at the end of Financial Year 2019-20 (July-June). In absolute terms, Pakistan’s external debt and liabilities have risen from $95 billion in December 2018 to $110.7 billion in December 2019 and $115.7 billion at the end of December 2020.

Much of this external debt was on account of public borrowing, amounting to $90.5 billion or 78 per cent of the end-December 2020 debt of $115.7 billion being on account of public debt. Not surprisingly, in 2019-20, the servicing of external public debt cost the government $11.9 billion, sharply up from $9.7 billion in 2018-19.

Rising external debt clearly reflects the government’s failure to mobilise adequate tax and non-tax revenues to finance its expenditures. It also results from a combination of accumulated foreign currency debt service commitments, deficits on the trade account of the balance of payments, and stretched public borrowing in domestic currency at home. Two-thirds of the increase in the government’s debt in 2019-20 was through domestic borrowing.

While excessive external indebtedness has structural roots, the problem has been aggravated by the COVID-19 crisis that adversely impacted both government revenues and export receipts. Foreign exchange reserves of around $12.5 billion in early February were equivalent to only about three months’ imports. If special assistance had not been arranged, matters would have been worse.

Foreign loans and aid

Pakistan has benefited to the tune of $1.7 billion from limited debt relief provided by the G-20 in the form of postponement of debt servicing payments, under its debt service suspension initiative.

Pakistan also received $1.4 billion from the International Monetary Fund (IMF) in April 2020 from the Rapid Financing Instrument created to support low-income countries affected by the pandemic. The IMF’s special assistance was principally meant to support health initiatives and a short-term fiscal stimulus. For the Pakistan government, it just meant much-needed budgetary resources.

China, too, has been accommodative. In March 2019, well before the COVID-19 crisis, when Pakistan was faced with balance of payments difficulties, China provided it a loan of $2.1 billion. At that time, Saudi Arabia and the United Arab Emirates (UAE) also pitched in with a billion dollars each. In fact, Saudi Arabia’s support was part of a $6 billion package involving $3 billion in credit and another $3 billion in deferred payments for oil imports.

However, in August 2020, in the midst of the pandemic, Saudi Arabia insisted on Pakistan repaying $1 billion of a $3 billion loan provided in 2018. This was reportedly because of the former’s annoyance over Pakistan’s insistence that the Organisation of Islamic Countries (OIC) officially come out against the Indian government for revoking the special status of Jammu and Kashmir under Article 370. The unexpected demand spelt a crisis for a debt-stressed government. But China stepped in with an offer of a matching $1 billion.

China to the rescue

China has always been quick to come to Pakistan’s aid. Soon after the pandemic broke, as early as March 2020, China provided Pakistan with a grant assistance of $4 million, besides material aid in the form of face masks, ventilators and other equipment.

The willingness of foreign donors to accommodate Pakistan’s demands, despite the perception that its problems stem from profligacy, is the flip side of the country’s debt problem. A significant share of Pakistan’s external debt is from official sources—$33.1 billion from multilateral sources and $14.6 billion from bilateral donors. The ever-present IMF contributed $7.4 billion as of December 2020.

Two factors played a role in ensuring official support. The first is Pakistan’s close relationship with neighbouring China and its important role in the latter’s Belt and Road Initiative (BRI). Bloomberg estimates the cost of BRI projects, both completed and under construction, at $33 billion.

The second is Pakistan’s complex relationship with the United States, and therefore with the IMF. Ever since receiving its first Extended Fund Facility (EFF) loan from the IMF in 1988, Pakistan has constantly been supported by the former. And though the IMF’s loans come with conditionalities, Pakistan has not suffered because of not implementing them in full, including targets set for the fiscal deficit aimed at reigning in new borrowing.

Special treatment by the U.S.

Notwithstanding breaches of conditionality, Pakistan has been rewarded repeatedly with new loans. Since 1988, the country has been under 13 IMF exceptional financing arrangements. As many 12 of these were stalled midway because of missed targets but were eventually revived. A December 2012 working paper from the London School of Economics titled “Pakistan, the United States and the IMF: Great game or a curious case of Dutch Disease without the oil?” by former IMF officials from Pakistan Ehtisham Ahmad and Azizali Mohammed notes: “A history of Pakistan’s relations with the IMF (and the Bretton Woods Institutions in general) cannot be told without reference to the complex and changing role played by the United States, especially since the mid-1980s when the Reagan administration stepped up responses to the Soviet Union in Afghanistan.”

This U.S.-inspired special relationship the IMF has had with Pakistan not only meant that it was repeatedly supported by new doses of multilateral credit (in addition to large volumes of bilateral flows), but also that it benefited from “exceptionally favourable conditionality and flexibility in giving waivers, on not meeting even soft conditionality standards”.

This special treatment has been visible recently as well. In October 2020, negotiations over the release of another tranche of funding under an ongoing three-year EFF programme signed in 2019, totalling $6 billion, were stalled. Pakistan, as has happened in the past, had not met conditions attached to the loan, relating to ostensibly revenue-enhancing tax reforms, upward flexibility of electricity and gas prices, reduced fiscal deficits, and a hike in (repo) interest rates by the central bank.

Faced with protests at home, Prime Minister Imran Khan did not want to be seen as promising to adopt austerity measures in the midst of a pandemic. Once again, both sides finally relented. The IMF promised to release $500 million of $2 billion due by March 2021. The government, on paper, agreed to implement measures to ensure debt sustainability and advance structural reforms. That is unlikely to happen, because Pakistan’s need to get the IMF programme going again was linked to its plans to borrow more from private global markets with a $1 billion Eurobond issue and a float of dollar denominated “sukuk” or Islamic bonds. This only means that come 2022, and when the current IMF programme ends, Pakistan would need another IMF loan to service the even larger external debt on its books.

Clearly, Pakistan’s debt problem is not solely the result of the government’s fiscal profligacy. It also has to do with a supply side debt push that results from the competing security ambitions of the world’s leading present-day rivals, the U.S. and China. The U.S. has tried pushing China back by implicitly prompting Pakistan to default on Chinese debt. Bilateral U.S. assistance and IMF support are often delayed on the grounds that the money would be used to repay debt to China. But that has not worked because China has been extremely accommodative when Pakistan finds itself unable to meet past commitments without receiving new flows.

In the event, Pakistan’s external debt and debt service burden continue to rise. And that will possibly remain true so long as it remains a strategic partner that cannot be dropped by the U.S. or China, occasional irritants and periodic disagreements notwithstanding .