Question
Case study The Economic Quandary of Pakistan: Following the Footsteps of Sri Lanka? Sri Lankan politico-economic crisis is an apt modern-day case study of epic
Case study
The Economic Quandary of Pakistan: Following the Footsteps of Sri Lanka?
Sri Lankan politico-economic crisis is an apt modern-day case study of epic proportions. Economic mismanagement, familial political hierarchy, and clueless policymaking have dealt this daunting reality to the island nation. A cursory review of the situation suggests that this debacle was waiting to wreak havoc for years. However, a comprehensive analysis uncovers an intriguing pattern of mishaps that actually hastened Sri Lanka's downfall. That pattern, somehow, carries an uncanny resemblance to the recent turn of events in Pakistan. Thus, the direction of Sri Lanka's current misery could foreshadow the nightmare in store for Pakistan. As I'm writing this article, the on-ground political chaos is running parallel in both the Asian underdogs. Protests are rampant, violence is reining on the streets, and stability is nowhere in sight. In the past few months, both countries have followed an identical playbook on the political front - to the letter! The No-Confidence motion against Imran Khan disillusioned his allied parties in a heartbeat. In mere weeks, Khan lost his hairline majority in the parliament. The subsequent fiasco eventually climaxed in Khan's exit and a regime change. In a parallel setting, extreme public pressure and mass protests distanced the coalition partners from Gotabaya Rajapaksa's ruling party. In early April, all 26 members of the Sri Lankan cabinet resigned en masse. Rajapaksa's simple majority of 113 faltered in the parliament as more than 40 members of the ruling coalition rejected his proposal of a 'national unity government' under his leadership. Country-wide protests and a brutal state of emergency ultimately led to the unexpected - the resignation of prime minister Mahinda Rajapaksa from the office. Now, both nations are in political limbo - one led by an isolated president while the other ruled by a coalition of fraying parties. Making matters worse, economic desperation is weighing heavily on the backdrop of the ongoing political turnover. The economics of the two nations - unlike the political drama - varies to a certain extent. Sri Lanka's tread toward instability started shortly after 2015. The Central Bank of Sri Lanka (CBSL) began engaging in Keynesian fiscal stimulus policy. By cutting interest rates and printing more money to close the output gap, the CBSL triggered an artificial forex shortage by using domestic savings to artificially boost the national credit system. This un-anchored monetary policy swelled the budget deficit and ushered three subsequent currency crises. While the strategy helped push inflation and spark ephemeral growth, low-interest rates and massive devaluation of the Sri Lankan Rupee (SLR) ultimately dried up the forex reserves. Today, Sri Lanka's usable dollar reserves amount to just $50 million - not enough to meet even a couple of weeks' worth of imports. Meanwhile, the SLR has dramatically plunged by more than 60% against the greenback. Debt servicing aside, the country is unable to import even food essentials, fuel, and medicines. That is a recipe for a humanitarian crisis waiting to unfold. Pakistan has similarly witnessed a sharp decline in its dollar reserves in the current fiscal year. From the record high level of $20.15 billion in August 2021, the forex reserves held by the State Bank of Pakistan (SBP) have shrunk by 50% to $10 billion. The main culprit is the intermittent debt servicing cost without matching investments to offset the decline. However, unlike Sri Lanka's interventionist soft-pegged exchange rate regime, Pakistan has rightly followed a clean float mechanism at the behest of the IMF conditions. While the Pakistani Rupee (PKR) has devalued by almost 100% in the last five years, the currency is not artificially supported. In fact, the Pakistan Real Effective Exchange Rate (REER) - PKR exchange rate weighted against a basket of 37 currencies of major trading partners - is settled in the 95-100 range: a level that makes exports more competitive and discourages imports. Unfortunately, Pakistan's imports are predominantly price inelastic, while quality exports are not nearly enough to cover the deficit. Hence, borrowing costs have consistently surged to finance the growing import bill - making Pakistan one of the highly indebted countries in South Asia. The final economic showdown in Sri Lanka was ironically shrouded in disguise of public welfare. The promise of a populist tax cut by the incumbent president Rajapaksa won him the election, yet also chanted a death spell on the economy already on the brink of collapse. A reduction in value-added tax from 15% to 8% with no alternate revenue replacement strategy understandably backfired. As revenue collection plummeted and the budget deficit expanded, the Sri Lankan regime revisited the original playbook - print more money. Moreover, the incompetent government banned crucial imports like fertilizers in order to conserve dollar reserves - sparking a domestic food crisis in hindsight. The pandemic unveiled the strategic idiocy of Sri Lanka as inflation spiraled, revenue from tourism vanished, and unemployment gripped like a vice. The invasion of Ukraine further debilitated the economy as global energy (and commodity) prices skyrocketed. As of April, inflation in Sri Lanka was as high as 29.8%, while food inflation climbed to almost 47%. Fuel prices have more than doubled, resulting in severe diesel shortages and power cuts. Today, Sri Lanka's sovereign debt default, a shortage of staples, and a dearth of dollar reserves - all elements serve as a reminder to Pakistan of what could be down the rabbit hole. Despite the possibility of a loan rollover from friendly countries, Pakistan is in desperate need of the resumption of the Extended Fund Facility (EFF) of the IMF program. Pakistan is scheduled to repay maturing bonds worth $4.5 billion by the end of this fiscal year. While, unlike Sri Lanka, Pakistan is not facing a prospect of a loan default - at least not in the short run - Pakistan's Eurobond yields have dramatically surged to 27% in the secondary market, signifying the increasing market sentiment of Pakistan's default risk on repayments of maturing global bonds. That being the case, other economic perils could further accentuate doom for Pakistan's precarious economy. According to the data published by the Pakistan Bureau of Statistics (PBS), the Consumer Price Index (CPI) measured the inflation rate surged in April to 13.4%. Food inflation clocked to over 17% in 2022 - after averaging 6.78% from 2011 to 2022. Despite a commendable growth of 25% in exports in the first ten months of the current fiscal year, imports more than doubled due to inflated global oil and commodity markets. Consequently, Pakistan's trade deficit crossed the $39 billion mark during the July-April period. A consistent inflow of record foreign remittances has suppressed the current account deficit to almost $14 billion in the same period. However, as the import bill is weighted heavily in fuel costs, the current account deficit would likely tilt toward $20 billion - about 6% of the national GDP - by the culmination of this fiscal year. Sri Lanka has already defaulted on its $51 billion foreign loans, and the IMF restructuring is underway to stabilize the economy. Sri Lanka is seeking $4 billion in a bailout package. And benefactors like India and China have stepped forward to extend credit lines, defer import payments, and even help alleviate the shortage of essential goods. However, the political vacuum and a lack of systemic governance would continue to asphyxiate the economy in spite of generous aid packages. On the other hand, Pakistan has accumulated record borrowings worth almost $50 billion during Khan's 45-month stint in power. Fortunately, the regime change in Pakistan has forestalled the impending collapse. Nonetheless, strict reforms and sensible economic policies are the need of the hour. In the short run, the remaining fuel subsidies - running worth billions of rupees per month - should be withdrawn immediately. As the currency depreciates organically, luxury imports should be further regulated, while value-added exports should be subsidized. The budget deficit is already running between PKR 5 trillion to PKR 5.6 trillion - beyond the budgetary target of PKR 4 trillion for the entire fiscal year. Hence, the government has resorted to borrowing - via floating Eurobonds and Sukuks in the international market and floating treasury bonds in the domestic markets. Yet, record-high yields in the secondary market have severed any immediate relief to the cash-strapped government of Pakistan. To avoid a trail towards default, Pakistan should rather focus on expanding the national tax base, suspending frivolous tax amnesty schemes to the elite industrialists, and curtailing interest rate payments by lowering the benchmark interest rate - currently hovering at 13.75%. In the last three decades, investment in both public and private sectors has consistently declined in Pakistan. Exports have more than halved while imports have multiplied. However, in just last six years, foreign debt has expanded by 200%; debt servicing costs have surged by 250%. The sheer imbalance should be an eye-opener for the policymakers of Pakistan. Almost 78% of Pakistan's federal tax collection is expended on servicing external loans. The country is not just in need of the IMF program; it is highly dependent to meet public expenditure targets. Hence, in the long run, Pakistan should focus on bilateral trade and Foreign Direct Investments (FDI) instead of abnormal external borrowing. Remittances should be earmarked to service external debt instead of importing luxuries. Furthermore, subsequent governments should prioritize food security through quotas and price caps instead of subsidizing squandering industries. Development of efficient oil refineries and enhancement of production capacity should also be prioritized to gradually phase away from expensive imported refined petroleum products. Ultimately, it is not too late for Pakistan. However, without any substantial intent toward improvement, continual heavy reliance on IMF and China, and procrastination of much-needed reforms - I reckon we are heading on a parallel Sri Lankan trajectory.
Explain in Three hundred words
Question- Explain why or why not, it can be said that Pakistan is 'following the footsteps of Sri Lanka'?
Add REFERENCE ALSO
Article - https://moderndiplomacy.eu/2022/06/01/the-economic-quandary-of-pakistan-following-the-footsteps-of-sri-lanka/
Step by Step Solution
There are 3 Steps involved in it
Step: 1
![blur-text-image](https://dsd5zvtm8ll6.cloudfront.net/includes/images/document_product_info/blur-text-image.webp)
Get Instant Access with AI-Powered Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
![blur-text-image](https://dsd5zvtm8ll6.cloudfront.net/includes/images/document_product_info/blur-subtext-image.webp)
Step: 3
![blur-text-image](https://dsd5zvtm8ll6.cloudfront.net/includes/images/document_product_info/blur-subtext-image.webp)
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started