Question # 02 (05 + 05 Marks)

Financial crisis is an economic situation in which the economy of a country faces some unanticipated downturn or recession, price fluctuations, current account deficits and uncertainty on foreign sector. By the end of June 2018, Pakistan had a current account deficit of $18 billion, nearly a 45 percent increase from an account deficit of $12.4 billion in 2017. Exorbitant import and less-than-projected inflows (export revenues and remittances) have led to a current account deficit widening, with foreign currency reserves levels covering less than two months of importspushing Pakistan towards a difficult economic situation. Part of Pakistans financial crisis stems from the fact that 2018 was a poor year for emerging markets. Global monetary tightening, increased oil prices, and reduced investor confidence have negatively impacted the countrys already precarious economic situation. But the countrys deep structural problems and weak macroeconomic policies have further exposed the economy to an array of debt vulnerabilities. Pakistan has had an overvalued exchange rate, low interest rates, and subdued inflation over the last few years. This loose monetary policy has led to high domestic demand, with two-thirds of Pakistans economic growth stemming from domestic consumption. An overvalued exchange rate has led to a very high level of imports and low level of exports. Pakistans high fiscal deficit was accelerated even further in 2017 and 2018 because elections have historically caused spending to rise. Perhaps the greatest financial issues facing Pakistan are its pervasive tax evasion and chronically low level of domestic resource mobilization. Taxes in Pakistan comprise less than 10 percent of GDP, a far cry from the 35 percent of countries that are part of the Organization for Economic Co-operation and Development (OECD). Pakistan also suffers from impediments in the energy sector through frequent and widespread power outages that hurt its competitiveness. Required: A financial crisis occurs when information flows in financial markets experience a particularly large disruption, with the result that financial frictions and credit spreads increase sharply and financial markets stop functioning.

i)- Comment and relate the above situation of Pakistan with the stages of financial crisis.

ii)- What are Pakistans options to enhance financial stability and well-being?