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The Crumbling Economy of Pakistan

Less than two years ago, the world was bursting with praise for Pakistan’s dynamic and resilient economy. 2018 saw Pakistan having its highest GDP growth rate in history. Moreover, its growth rate consistently increased from 2013 to 2018. Undeniably, Pakistan had a long history of economic battles, but somehow it had emerged from them with an indomitable spirit. The economy, despite its long struggles, seemed to be on the road to victory.

However, the scene today is drastically different.
The Pakistani economy is showing a GDP growth rate of a meagre 3.9 percent for this year, the lowest in a decade. Its inflation rate is sky-high. The Pakistani rupee is dropping in value and a third less than what it was in the international markets two years ago. Unemployment is in double digits. Moreover, the predicted growth rate for the next two years is even lower.

Imran Khan and his government had promised ten million new jobs and five million new houses. Instead, the economy is facing a crippling crisis, with fast-depleting foreign reserves.

There is no denying it. On all accounts, the economy of Pakistan is on the brink of collapse. How did the state of the economy change so quickly?

The answer is surprisingly simple, and not a new one. A common recurrence in Pakistan is its balance of payments crisis.

Now, 2018 was a bad year for emerging markets with low investor confidence, tightening global policies and increasing oil prices. These factors did not leave any economy in the world unscathed, but Pakistan was especially affected due to fundamental problems of its weak macroeconomic policies and deep-rooted structural issues. Over the last few years, Pakistan had an overvalued exchange rate, low interest rates and a subdued inflation rate, leading to high domestic demand. A combination of high imports and low exports has resulted in a fiscal deficit.

The major driver of its rising current account deficit is an expanding trade deficit due to rising imports under the China-Pakistan Economic Corridor (CPEC) projects and generally low exports. Heavy expenditure on this project has risen its current account deficit from $2.7 billion in 2015 to $18.2 billion in 2018.

Chinese investment seems to be the main driver of the Pakistani debt crisis. China’s Belt and Road Initiative (BRI) makes Pakistan its key partner in the $60 million CPEC project. Pakistan is raking up huge unsustainable bills while supporting China’s infrastructure plan.

Pakistan’s economic woes- current account deficits, dwindling foreign reserves, high inflation- are nothing new. For the 22nd time, they received an IMF bailout of $6 billion yesterday, provided over three years. In a statement, the International Monetary Fund (IMF) said Pakistan faces a “challenging economic environment, with lacklustre growth, elevated inflation, high indebtedness, and a weak external position.”

It further said the funding programme would support the authorities’ strategy for stronger growth by “improving the business environment, strengthening institutions, increasing transparency, and protecting social spending.” This bailout comes after some loans were provided by China and Saudi Arabia, without which the Pakistani economy would not have stayed afloat for so long.

However, the IMF has imposed strict conditions to provide the loan to Pakistan. They have asked for a commitment that the Pakistani rupee rate be determined by the market instead of the Central Bank.

Why does the Pakistani economy seem to be in perpetual crisis mode? Firstly, tax evasion is a major problem. A population of hardly one percent of Pakistan forms the tax base. Tax evasion is rampant because of legal loopholes and low tax morale. Taxation is not generally considered a civic duty because well-off households do not rely on public education and health facilities and thus have little incentive. Moreover, legal loopholes facilitate evasion. The law on Benami Transactions (2016) prohibiting anonymous transactions was not improved because secondary regulations were not approved. Prize bonds are favoured as an anonymous and tax exempt choice for investing funds. Low taxes on immovable property promote money laundering.

The tax system in Pakistan is regressive, focussing more on low indirect taxes. Most of the income tax is collected through withholding agents due to the limited capacity of the administration. Since the withholding agents are required to levy income tax on transactions at the same time as general sales tax, income tax essentially becomes an indirect tax. The withholding regime is onerous and weakens the financial system.

Secondly, increased defence expenditure, and a huge focus on geostrategy instead of geoeconomics has harmed the economy. There is huge military expenditure, yet terrorism and crime is prevalent.

Thirdly, terrorism and extremism prevent foreign investment. Fourthly, a poorly regulated financial system with obsolete policies prevails in the economy. Fifthly, a chronically low level of domestic resource mobilisation is the norm. Sixthly, an old-fashioned industrial sector that cannot compete in the international market. Seventhly, the economy’s ongoing energy crisis has also resulted in a significant loss of money. Other reasons include corrupt, inefficient government regimes and low growth in income and exports.

An expansionary fiscal policy with a narrow tax base, and the failure to enhance exports or attract foreign direct investment is a recipe for trouble. Moreover, unlike other Asian countries, Pakistan failed to ride the wave of globalisation, causing poverty and a low-value currency.

The path forward for Pakistan is fraught with difficulties, but clear. Pakistan needs to remedy its loose macroeconomic, fiscal and monetary policies. To significantly affect the current account deficit, Pakistan would have to become investor-friendly and encourage trade on a massive scale. They will have to attract Foreign Direct Investment (FDI) instead of relying heavily on foreign trade. According to the World Bank’s Ease of Doing Business Report, Pakistan has a rank of 136 out of 190 economies. Their priority should be improving this rank by easing customs regulations and increasing security. Pakistan needs to rebrand and make its image favourable for tourism and trade. It needs to crack down on terrorism and increase investor confidence. Moreover, strict laws must be implemented against tax evasion. Pakistan’s tax base needs to be broadened. Currently, the agricultural sector and many businesses are given tax concessions. They should be taxed instead of overburdening the current tax payers.

Furthermore, Pakistan should expand its export portfolio beyond the few low-value products such as textiles, rice, surgical goods, etc. This will correct one of the major reasons for the current account deficit. New export destinations should also be explored. Pakistan should also expand its competitiveness in the international market by increasing its rank on the Global Competitiveness Index (GCI). Currently, Pakistan ranks 107 out of 180 countries. New measures need to be taken to stimulate economic growth and provide a favourable business environment.

Lastly, Pakistan’s energy crisis has caused many factory owners to relocate to countries such as Bangladesh. Also, Pakistani products lose out to cheaply-produced, better quality products from its neighbouring countries. Research and development must be carried out and the industrial sector should be modernised.

A few measures have been imposed by the IMF as well. They have asked Pakistan to lower public debt and increase their tax base. They will assist Pakistan in this by allocating several resources like investing in high poverty areas, developing social assistance schemes and supporting economic empowerment of women. The IMF wants to Pakistan to have economic stability while still prioritising the public’s interests, indeed no less than a Herculean task.

The world is of the opinion that Pakistan has taken too much of a gamble by partnering with China for the Belt and Road Initiative. However, one thing is certain. Ultimately, it is irrelevant that the economy’s crisis was caused by investment in this project. It was only the topmost factor on a pile of structural flaws. These critical flaws in the Pakistani economy will cause it to topple over again and again. These problems will not be resolved overnight, but if they are ignored and avoided, Pakistan’s unstable economy will fatally collapse to the point of no return.The hour has come for Pakistan to build a truly sustainable and stable economy and live up to its potential. Will it succeed? Only time will tell.

By Bhavya Verma,
from The Shri Ram School Aravali, Gurgaon.
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