The rise in prices of crude oil on the global markets, difficulties in conducting business transactions with Gulf nations due to the ongoing conflict, as well as the protracted Russia-Ukraine war have increased the risks in the external sector of the economy.
Foreign exchange reserves of Pakistan were quite impressive at the end of September with a value of $21.4 billion, which provided much needed relief in the context of the prevailing uncertainties in the economy. The reserves represent a buffer stock worth of only around three months of import bill and are generally regarded as the bare minimum standard set by international finance institutions.
Any further rise in the cost of imports and any kind of disruption to the foreign exchange flows will render the situation vulnerable. The major shortcoming in the external sector of Pakistan is that there has been no significant rise in exports to match the level of imports. This discrepancy continues to push the country into the same old boom and bust cycle again and again. When the economy witnesses an improvement in its performance, the demand for imports starts increasing.
While measures to curb imports may help to reduce the current account deficit in the short term, they do influence industrial production and economic growth, too. Businesses reliant on imports find it difficult to sustain their output levels, and uncertainty regarding access to raw materials tends to discourage investment. Once restrictions are lifted, demand for imports rebounds, adding pressure on the external position of the economy. This has been a recurring pattern in Pakistan, indicating that import compression cannot be a sustainable solution to the country’s balance-of-payments problem.
These latest numbers highlight the continuing nature of the problem. The current account deficit of Pakistan has risen to $874 million in the first quarter of FY27 (July-September 2026), from $755 million in the same period last year. While the amount itself may not appear alarming, the trend is important at a time when there are still significant needs for external financing.
In the case of a consistent current account deficit, there is a need for a nation to earn foreign exchange through borrowing, investments, remittances or even through the available reserves. Pakistan has often had recourse to multilateral funding agencies to address this situation. Although this approach prevents a crisis from developing, continuous borrowing leads to higher debt levels, thereby exposing the economy to the vagaries of international finance.
Then there is the issue of exchange rates. Various independent economists have questioned the strength of the rupee against the US dollar, especially when there has been a devaluation in the exchange rates of various trading partners. An exchange rate that is stable ensures that there is stability in the import price level while also enabling business people to plan better.
In its evaluation of the economy of Pakistan, the International Monetary Fund has continuously highlighted the need for exchange rate flexibility. In a statement issued in October, the Fund highlighted that exchange rate flexibility should continue playing its role as a major shock absorber. The other requirements included increased reserve holdings, gradual foreign exchange liberalisation and deepening of domestic financial markets to increase resilience and facilitate the development of the private sector.
It shows how external stability through administrative means has its own limitations. Exchange rate flexibility backed by sound economic policies will make sure that the economy is able to cope with any external shock. The only problem is that exchange rate flexibility has to be backed by steps to increase productivity, export performance and protection of poor households against higher costs of living.
Another area where Pakistan is falling short is that of foreign investment. Foreign direct investment in the last fiscal year amounted to $1.6723 billion while portfolio investment had a net outflow of $1.186 billion. Hence the net flow of funds from both these sources comes up to around $486.1 million. Such levels of investment are inadequate for meeting the requirements of an economy aspiring towards growth and a sound external position.
This is despite the fact that there has been an increase of 3.51 percent in the stock market index. The reason why this might be happening could be due to the fact that portfolio investment has been negative even while the stock market index has increased.
The subinvestment grade creditworthiness of Pakistan makes it harder for it to attract investment under favorable terms. Investors consider political uncertainty, risk of currency fluctuations, expenses associated with energy, regulation, and the capability of the government to honor its debts. Thus, a good environment for investments is created by stable policy, quality infrastructure, proper regulation, and assurance that firms would have a predictable legal environment when conducting business.
Public debt is yet another problem. While the ratio of public debt to GDP continues falling, one has to take into account the change in the structure and the cost of public debt. The transformation of short-term debt into long-term debt is helpful to lower the refinancing problem, but it might result in higher interest expenses. The extension of terms of loan repayment does not necessarily mean that there is no debt problem.
The recent issuance of Eurobonds worth $3 billion by the government is one example which highlights these risks. The country has generated $1.75 billion via Eurobonds at the rate of 7.5 per cent for five and a half years and $1.25 billion at the rate of 7.9 per cent for a ten-year period. Although these dealings help the country to generate foreign exchange immediately, yet they result in a huge liability for the country in the form of future obligations of dollars. Should the rupee devalue prior to the payment period, the cost of servicing the debt in terms of domestic currency would go up even more.
The risk of financial liability in the energy sector is also very high. For instance, payments owed to Chinese IPPs have been reported to be worth Rs498 billion and the circular debt in the energy sector has crossed Rs2 trillion. These liabilities could also pose a threat to the country’s finances in the form of various government subsidies, guarantees, delays in payments etc.
A new strategy is needed to tackle these interrelated issues. Reforms in the tax system must expand the revenue base while not overburdening the taxpayer who is already paying taxes. In the energy sector, there is a need to lower costs and increase efficiency as well as addressing the root cause of circular debt. Export oriented industries need a stable policy framework, reliable and affordable energy and advanced technology among others.
There is also need to encourage productive foreign investment instead of relying too much on the inflow of financial resources from abroad and overseas borrowings. There will be confidence among investors if economic policies are consistent and certain. Education, skills, infrastructure and technology will also play an important role in making local businesses move to more value added products and exports.
The constant resorting to the IMF programs by Pakistan poses a crucial question regarding the effectiveness of its economic policy. Over several decades, Pakistan has implemented roughly 25 agreements with the Fund; however, many of the structural problems that have led to the need for earlier programs have not been addressed. The international help can help stabilize the economy but it cannot replace the internal reforms aimed at improving the productivity and increasing the export capacity.
Pakistan has to make use of the resources that it already has and the breathing room created by the international help in order to implement sensible and consistent economic policies. The implementation of the IMF requirements might be essential in order to keep up the access to the loans; however, the ultimate goal has to be to minimize the dependence on the loans.