FeaturedNationalVOLUME 19 ISSUE # 14

Dual crisis of debt and climate vulnerability

As Pakistan grapples with the aftermath of closely contested elections and looming political uncertainties, a more profound crisis unfolds, the intersection of escalating debt and increasing vulnerability to climate-related challenges.

Fitch, the global ratings agency, has cautioned that the closely contested outcome of the February 8 polls in Pakistan, coupled with the resultant near-term political uncertainty, may complicate the nation’s efforts to secure a financing agreement with the International Monetary Fund (IMF). The 12th general elections saw the participation of nearly 60.6 million Pakistani voters amid a day-long suspension of cellular services and rigging allegations.

Despite the large voter turnout, the election results yielded a split mandate, with PTI-backed independent candidates emerging on top in the National Assembly elections. Subsequently, the PPP and PML-N initiated efforts to devise a power-sharing formula in the national and Punjab assemblies, while the PTI announced an alliance with the Sunni Ittehad Council in the Centre, Khyber Pakhtunkhwa, and Punjab.

In a recent report, Fitch Ratings, a prominent US-based rating agency, emphasized the importance of a new IMF deal to succeed the expiring Stand-By Arrangement (SBA) in March 2024 for Pakistan’s credit profile. The agency assumed that an agreement would be reached within a few months, but it warned that prolonged negotiations or failure to secure the deal could elevate external liquidity stress and increase the risk of default.

While acknowledging Pakistan’s recent improvement in external position, with net foreign reserves reaching $8 billion as of Feb 9, Fitch noted that this remains low relative to projected external funding needs, expected to exceed reserves for the next few years. The agency estimated that Pakistan met less than half of its U$18 billion funding plan in the first two quarters of the fiscal year ending June 2024, excluding routine rollovers of bilateral debt.

Fitch highlighted the urgency for the next government, likely to be a coalition of PML-N and PPP, to secure financing from multilateral and bilateral partners due to the sovereign’s vulnerable external position. Negotiating a successor deal to the SBA and adhering to the policy commitments under it would be critical for external financing flows, influencing the country’s economic trajectory in the longer term.

It acknowledged the likelihood of challenges in finalizing a new IMF deal, anticipating tougher conditions compared to the current interim SBA. However, it assumed that resistance would be overcome given the acute economic challenges in Pakistan. The agency cautioned that prolonged political instability could hinder discussions with the IMF, delay assistance from other partners, or impede reform implementation. Fitch also pointed out Pakistan’s historically poor record in completing IMF programs but noted a stronger consensus on the need for reform, potentially facilitating the implementation of a successor arrangement.

The rating agency has expressed concern that policy risks may increase over time if external liquidity pressure eases, potentially leading to a renewed accumulation of economic and external imbalances. Fitch emphasized that Pakistan’s external finances are expected to remain structurally weak unless there is development in the private sector, generating significantly more export income, attracting foreign direct investment (FDI), or reducing import dependence.

Meanwhile, Pakistan is grappling with an unsustainable level of total public debt and liabilities. The country’s external debt has doubled, and domestic debt has increased six-fold since 2011. A detailed report from the think-tank Tabadlab, titled “A Raging Fire,” highlights the severity of the crisis, outlining the financial resources deficit, the depth of the problem, and potential paths forward with or without transformative structural changes.

The report notes that in nominal terms, Pakistan’s external debt has nearly doubled, and domestic debt has increased six-fold since 2011. In the fiscal year 2024, Pakistan is projected to repay an estimated $49.5 billion in debt maturities, with 30% attributed to interest and none from bilateral or IMF loans. The report underscores that debt accumulation has been predominantly used to sustain a consumption-focused, import-dependent economy, without adequate investment in productive sectors or industry.

Pakistan’s debt profile is characterized as alarming, and its borrowing and spending practices are deemed unsustainable. The growing demands of a burgeoning population for social protection, health, education, and climate change-related initiatives necessitate additional financial resources. The intertwined challenges of climate and debt vulnerability provide an opportunity to synergize efforts and address both existential crises simultaneously.

The report highlights Pakistan’s shortened boom-and-bust cycles, emphasizing consumption-driven growth rather than industrialization or enhancement of productive sectors. Persistent current account deficits, limited foreign currency inflows compared to outflows, and perennial fiscal deficits contribute to the need for extensive borrowing to meet various requirements, including climate change and resilience efforts.

The unsustainable growth in the quantum of debt, outpacing the net output of the economy (GDP), signals the necessity for transformational change. Without sweeping reforms and significant alterations to the status quo, Pakistan faces the risk of sinking deeper into a spiral towards an inevitable default. The report suggests that leveraging climate swaps could be a potential solution to mitigate both the challenges posed by climate needs and Pakistan’s mounting debt profile.

In the face of mounting challenges, “A Raging Fire” concludes with a stark realization: Pakistan’s debt trajectory is unsustainable, demanding immediate and strategic interventions. The country’s economic landscape necessitates a paradigm shift, away from a consumption-focused economy towards a sustainable and resilient model. Highlighting the urgency of addressing climate vulnerabilities, the report proposes leveraging climate swaps as a potential solution. The blueprint provided serves not only as a guide to extricate Pakistan from its perpetual financial spiral but also as a pathway to economic recovery, ultimately leading to prosperity. The report underscores the critical need for sweeping reforms to avert an inevitable default and urges concerted efforts to synergize climate and debt mitigation strategies for a sustainable future.