Pakistan’s Debt Spiral: Challenge to Economy

Recently, Pakistan secured the first tranche of the IMF-led bailout package, highlighting the diplomatic success of the incumbent government and Foreign Office. This development has eased some economic burdens and fostered optimism among investors. ADB Country Director for Pakistan, Yong Ye, noted that “Pakistan’s economy is showing signs of a gradual recovery supported by higher crop output and improvement in manufacturing.” Also Pakistan’s successful hosting of the Shanghai Cooperation Organization (SCO) summit underscores its strategic importance and commitment to regional cooperation in addressing pressing economic challenges.

This, coupled with the recent International Monetary Fund (IMF) bailout, highlights the urgent need for collaborative efforts to navigate Pakistan’s escalating debt crisis and support sustainable long-term economic recovery. However, significant challenges remain, with the IMF describing the country’s external debt repayment capacity as “fragile.” The IMF’s assessment reveals external financing needs of $62.6 billion over the next three years under the Extended Fund Facility (EFF) program, projected to reach $110.5 billion from 2024-25 to 2028-29. These figures underscore the urgent need for timely reforms to ensure Pakistan’s economic stability and growth.

The IMF projects Pakistan’s external financing needs at $18.813 billion for the current fiscal year, escalating to $20.088 billion in 2025-26 and $23.714 billion in 2026-27. What’s particularly troubling is that even after the completion of the 3-year programme, there appears to be no respite in sight. The financing needs are expected to remain astronomically high, standing at $24.625 billion in fiscal year 2027-28 and $23.235 billion in 2028-29. These figures are not just numbers, they represent looming crises that threaten to engulf Pakistan’s economy.

Instead of addressing the root causes of its economic woes, Pakistan has relied heavily on external borrowing, creating a vicious cycle of debt that seems increasingly difficult to break. The IMF’s assessment highlights Pakistan’s economic challenges, pointing to missed opportunities for structural reforms and reliance on short-term measures. Misallocation of resources has worsened vulnerabilities, while essential sectors like education, healthcare and infrastructure remain underfunded. This imbalance hampers economic growth and deepens social inequalities, underscoring the need for a shift in policy priorities.

Pakistan’s energy sector remains a major economic burden, struggling with inefficiencies, circular debt and unsustainable subsidies. Despite IMF programs, focusing on energy tariff hikes without addressing structural issues may raise production costs and weaken the country’s export competitiveness further. The tax system in Pakistan is another area of grave concern. With tax revenues at a mere 12% of GDP, while expenditure hovers around 20%, the country’s fiscal deficit continues to widen. The new IMF program pushes for additional tax measures equivalent to 3% points of GDP, but these measures are likely to face significant political resistance.

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More importantly, they fail to address the fundamental issues of tax evasion, a narrow tax base and the presence of powerful lobbies that continue to enjoy tax exemptions. Pakistan’s recurring balance of payment crisis reflects deeper structural issues in its economy, including a narrow, undiversified export base vulnerable to external shocks. Foreign direct investment has declined due to security concerns, policy inconsistencies and a difficult business environment. While remittances remain significant, they are not a sustainable long-term solution. The latest $7 billion IMF bailout, Pakistan’s 25th, offers short-term relief but fails to address underlying problems. Without tackling these long-term structural challenges, Pakistan remains stuck in a cycle of economic crisis and external dependence.

One of the most pressing concerns is Pakistan’s mounting debt burden. With interest payments consuming a staggering 68% of tax revenue in FY 2023, the country is caught in a debt trap that severely limits its ability to invest in productive sectors. The IMF’s projection of gross external financing needs of up to $146 billion for FY 2024 to FY 2029 underscores the magnitude of the challenge ahead. Merely lurching from one IMF program to another without addressing the underlying issues will only prolong the country’s economic agony.

What Pakistan needs is a comprehensive, home-grown economic reform agenda that goes beyond the prescriptions of international financial institutions. Such an agenda should focus on diversifying the export base, improving the ease of doing business, rationalizing government expenditure and broadening the tax base. It must also include bold measures to reform state-owned enterprises, tackle corruption and improve governance. Most importantly, it should prioritize investment in human capital and infrastructure to lay the foundation for sustainable, long-term growth.

The political leadership must also muster the courage to make tough decisions, even if they are unpopular in the short term. This includes phasing out unsustainable subsidies, particularly in the energy sector and implementing a more progressive taxation system that ensures the wealthy pay their fair share. Furthermore, Pakistan needs to seriously consider the option of debt restructuring. While this comes with its own set of challenges, it may be necessary to create fiscal space for much-needed developmental expenditure.

Pakistan stands at a critical juncture. The IMF’s latest assessment serves as a stark warning of the economic catastrophe that awaits if decisive action is not taken. The country’s leadership must focus on implementing deep-rooted, structural reforms. Failure to do so risks not just economic stagnation, but potentially a full-blown economic collapse that could have severe social and political repercussions. The time for half-measures and stopgap solutions is over. Pakistan must act now or risk being trapped in a cycle of debt and dependency for generations to come.
(Source: Pakistan Observer)