ISLAMABAD: Pakistan is another Sri Lanka in the making if not stopped by taking steps the failing island nation has not taken, according to the latest report from the Institute for Policy Reforms (IPR). With an external debt that has increased by 200% over the last six years and exports that have only increased by 3%, what could NOT go wrong?

“The external debt and current account deficit are not only the biggest economic problems, they are a national emergency. Resolving them is essential for economic recovery and security. If this is not done, there is every chance that the economy will either default or face a Sri Lankan-like situation,” said the authors of the report titled What to do about the debt mountain of the Pakistan? Here are the findings of the report that go further.

The war in Ukraine, with the resulting supply problems and inflation, further aggravates an already intractable situation. The pressure of continuous borrowing for consumption and debt service without developing the means to repay the loans weakens the external account.

There is also a trend towards deteriorating sustainability ratios as well as a preference for shorter tenure and higher cost debt. Total external debt was less than $60 billion in 2015. In six years, it has more than doubled to over $130 billion in December 2021, and borrowing continues. However, in those six years, exports of goods and services barely increased, from $30.5 billion to $31.5 billion in FY21.

External debt increased by more than 200% during this period and exports by only 3%. Over the same period, debt service, principal plus interest, jumped about 250%. All sustainability indicators deteriorated.

With regard to the duration and cost of debt, between 2010 and 2021, the share of low-cost, mainly long-term debt of the Paris Club fell from 25% to 8.8%, while the share of multilateral loans fell from 42.7% to 27.6%. In contrast, the share of high cost bonds/sukuks increased from 2.7% to 6.4%, commercial loans from zero to 8.4% and other bilateral loans from 3% to 16%.

Behind the repeated crises, there is a collapse of policy-making. For example, Pakistan has a constant trade deficit. This is because of declining investment and production, but no effort is being made to increase it. When we invest and produce less, we have to import more, financed by foreign loans. When the economy grows by 2-3%, Pakistan’s exports and remittances are sufficient to cover most imports. But when the economy grows by around 5% or when energy prices suddenly increase, we need more loans. This causes an increase in the payment of interest and principal and therefore the crisis.

A plan to avoid future current account crises should be central to any substantive engagement with the IMF and other partners. Not just racking up debt upon debt.

The main objective of the IMF is to help a struggling economy overcome an emergency. This is done in the hope that the country would make the reforms to avoid a future crisis. As evidenced by our more than 20 visits to the IMF, Pakistan is not reforming. The depth of reforms that Pakistan needs can only be addressed through strong and committed leadership engaged with the people of Pakistan and working for growth and development.

The economy takes years to recover from each crisis. And we pay huge sums to external creditors and suppliers of goods. The ensuing devaluation, high interest rates and government spending cuts impoverish citizens and depress economic activity. It is now a regular occurrence.

The sum of infrastructure, human resources and institutional assets of the economy is good for the economy to grow by up to 3%. Obviously, a growth rate of 2-3% is not acceptable.

All this has distorted the spending of the GoP (Government of Pakistan). In FY21, 38% of federal spending repaid only interest on domestic and foreign debt. It was 78% of federal revenue. Most of the other expenses were covered by loans. Public investment in infrastructure and human capital has been drastically reduced to meet debt repayment. In addition to interest payments, grants consume a lot of funds. IPPs are an example of this, as are loss-making ESPs.

What should Pakistan do? Policy makers need to be serious. The IPR recommends that each year the GoP set targets for fiscal and current account deficits and trim its coat accordingly. The GoP could also allocate part of the $30 billion in remittances to repaying foreign debt, by limiting imports.

In addition to indirect taxes, the GoP should increase direct taxes and reduce exemptions. And we may have to seek debt relief from international creditors. To convince lenders that we want to avoid future crises, we must adopt a solid plan for economic growth and the correction of elite privileges.

Until exports can increase significantly from the production of more goods, the government must do an article-by-item study of what the export could increase rapidly, possibly with incentives. Likewise, it must remove all imports of non-essential goods and conduct an item-by-item review to find domestic substitutes for them and quickly put certain items into production with incentives.

In addition to a Saudi facility for deferred oil payment, we can request the same from Qatar. Restrict portfolio investments and end the volatility and shifting of resources they entail. And gradually, we need to start accessing external debt to finance only projects that create GDP and export growth. If more than 70% of the new debt is consumed, the crisis will never go away.

Getting out of the crisis would be neither simple nor quick. This is a gradual process also facilitated by certain medium-term measures such as making the electricity sector more sustainable and reliable. We can also restructure domestic debt. And we need to redirect public investment to help drive export growth and secure more credit to the private sector, concludes the IPR report. —