Pakistan is mired in a worsening economic crisis. Foreign reserves have plunged more than 40 percent since the beginning of this year to a nearly five-year low. Government debt has increased by nearly 80 percent since 2013. Prime Minister Imran Khan said candidly last month that Pakistan is “desperate” for loans.
Why the Crisis Matters
Heightening Pakistan’s economic vulnerability is its presence, since June, on a watchlist of the Financial Action Task Force (FATF), a global forum that monitors terrorist financing. The longer Pakistan is listed, the more uncomfortable foreign investors will become about providing financing. And Pakistan is unlikely to be delisted anytime soon. A chief FATF concern is Pakistan’s failure to curb the finances of Jamaat-ud-Dawa (JuD), a political organization and charity linked to Lashkar-e-Taiba, a U.N.-designated terror group. Last month, instead of complying with FATF’s concerns about violent extremist groups operating in Pakistan, Islamabad removed JuD from its list of banned organizations.
Too, an extended crisis could spark unrest in a country prone to violent protests over food costs and energy shortages. Despite effective operations against anti-state terrorists, Pakistan remains volatile. The formation last year of new hardline religious political parties that advocate violence and can mobilize quickly and sometimes violently — as they did last week— underscores the entrenched threat of extremism. These groups, along with sectarian extremist outfits like Lashkar-e-Jhangvi, could exploit economic stress by scapegoating and threatening vulnerable communities.
Moreover, an intensifying economic crisis could undermine Washington’s core interest in Pakistan: security. Additionally, if Islamabad is increasingly distracted by a currency crisis, Washington could have trouble securing its assistance in stepped-up U.S. efforts to launch peace talks with the Taliban in Afghanistan.
It’s Not Just China’s Fault
Pakistan’s economic woes can largely be attributed to poor export performance and expensive imports. Pakistan hasn’t managed to diversify its export mix away from low-value-added textiles, despite high growth potential in areas such as construction and IT. Meanwhile, Islamabad relies on pricey imports, particularly Middle East-sourced hydrocarbons, to compensate for inadequate domestic equivalents. Imports associated with the China-Pakistan Economic Corridor (CPEC) contribute to this problem, but they are the tip of the iceberg.
Similarly, CPEC loans are not the only reason for Pakistan’s indebtedness. The domestic debt of Pakistan’s public corporations soared by nearly 250 percent between 2013 and 2018. Continuous loans and imports from China exacerbate Pakistan’s economic problems, but CPEC is not uniquely responsible.
Difficult Negotiations Ahead
Islamabad has an immediate economic recovery plan: Secure financial support from its closest friends and negotiate a bailout package with the International Monetary Fund (IMF) to cover the rest of its short-term needs. In Islamabad’s mind, the more support it gets from bilateral partners, the less it has to ask from the IMF. Still, these talks, which begin this week, won’t be easy.
First, Islamabad must strike a deal without appearing to capitulate to the IMF completely. Going to the IMF is never popular in Pakistan, and with the current government vowing to transform Pakistan’s economy into an “Islamic welfare system,” requesting a bailout from a preeminent Western financial institution looks bad. Shortly after the ruling party took power in August, a party insider told me that Islamabad viewed the IMF as a last resort. A recent$6 billion deal with Saudi Arabia (and a possible one with China to follow), which will reduce Islamabad’s ask of the Fund, should blunt public anger.
Second, Islamabad must avoid damaging its close relationship with Beijing, which has never been more important for Pakistan as ties with Washington deteriorate. The IMF will likely insist that CPEC financing terms be subjected to scrutiny — a move that might worry Beijing. However, Islamabad could persuade China that this scrutiny, and the changes in financing terms it may entail, represents an opportunity to renegotiate CPEC loans to make them more viable for Pakistan and thus more desirable for Beijing. China doesn’t want prohibitive borrower debt to jeopardize CPEC, a critical Belt and Road Initiative component.
A Band-Aid at Best
Washington’s core interest in Pakistan is stability. It should use its influence within the IMF — where it is the largest donor — to insist on loan conditions that help ease a potentially destabilizing currency crisis.
Above all, it should press the Fund to demand demonstrable Pakistani steps to restructure or privatize struggling public corporations, a chief source of debt. This could benefit Washington by slowing its top rival’s investments in Pakistan. James Schwemlein, a former State Department senior advisor on Pakistan, has argued that transport-related CPEC projects could hit roadblocks if public corporations involved in them, such as Pakistan Railroads, are targeted for restructuring. Pressing the IMF to ensure funds aren’t used to pay back CPEC loans — as Secretary of State Mike Pompeo threatened in July — would be misguided. Repayment deadlines for many CPEC loans are not for at least another decade.
Ultimately, bailouts from bilateral partners and a new IMF package amount to band-aids for Pakistan’s bleeding economy. Until Pakistan makes concerted efforts to diversify its export portfolio, increase its tax base and address crippling agricultural water shortages, any economic relief will be temporary.
The Khan administration’s longer-term economic plan currently consists of little more than rhetoric — vowing to recover wealth plundered overseas, calling on the diaspora to open its wallet — that plays to the ruling party’s populist and anti-corruption plank. Unless the government initiates real change, Pakistan eventually will experience economic déjà vu all over again.
Michael Kugelman is the Deputy Director of the Asia Program and Senior Associate for South Asia at the Wilson Center. Kugelman is a leading specialist on Afghanistan, India, and Pakistan and their relations with the United States. He is the editor or co-editor of 11 books and has written for Wall Street Journal, The New York Times, Foreign Policy, Foreign Affairs, and other publications, covering topics ranging from U.S. policy in Afghanistan to terrorism to water, energy, and food security in the region.