In the first half of 2023, Pakistan appeared to be moving toward a catastrophic economic default. An IMF loan program Pakistan entered into in 2019 had gone off track after the Fund found Islamabad’s commitment to reform lacking, leading to a suspension of loan disbursements. The derailment of the IMF program resulted in a significant drop in the country’s foreign exchange reserves — at one point this year, reserves could only cover about two weeks' worth of imports due to concurrent debt repayment pressure. To avoid defaulting, the government imposed stringent import restrictions in an attempt to control dollar outflows. That caused a major economic shutdown of import-dependent industries, a shortage of essential commodities and surge in inflation.

Volunteers distribute bread for people to break their fast during the Muslim holy month of Ramadan in Islamabad, Pakistan, on April 15, 2023. (Saiyna Bashir/The New York Times)
Volunteers distribute bread for people to break their fast during the Muslim holy month of Ramadan in Islamabad, Pakistan, on April 15, 2023. (Saiyna Bashir/The New York Times)

Yet by late June the Pakistani government had managed something of a turn-around. The IMF announced a new nine-month program with a $3 billion Stand By Arrangement (SBA) as an emergency stop-gap measure. Economic support also came from Pakistan’s Middle East partners and China. Although the risk of default has since receded, significant economic challenges remain for Pakistan, including forthcoming negotiations with the IMF and seeking additional aid from foreign backers, particularly Saudi Arabia and the UAE.

The Pullback from the Precipice

Since 2019, Pakistan had been struggling in an IMF program, repeatedly failing to meet reform commitments, and encountering disbursement delays. Relations between Pakistan and the IMF soured further in February this year when both parties failed to reach an agreement to revive the program, resulting in blocking of a billion dollars of loan by the IMF and the suspension of program loans by other international financial institutions like the World Bank. The disagreements hinged on two issues: the amount of financing required by Pakistan for its import bill and debt repayment, and the restrictions imposed on imports, as well as artificial control over the exchange rate.

Bureaucratic mismanagement contributed to significant delays, while Pakistan’s finance minister at the time, Ishaq Dar, also resisted demands to lift restrictions on exchange rate and imports. Dar exacerbated the controversy by attributing the obstacles to “geopolitics,” a reference to the United States blocking the program due to Pakistan's alignment with China. This excuse was intended to deflect domestic political criticism but only deepened mistrust between Dar and the IMF.

In June, with negotiations stalled and the default looming, Pakistani Prime Minister Shehbaz Sharif reached out directly to the IMF. Reports suggest Sharif had been unaware of Pakistan’s precarious situation, only learning of its gravity in an emergency meeting with the IMF's managing director in Paris. Consequently, Sharif agreed to all the IMF's requirements, leading to the new SBA agreement.

China also played a pivotal role in preventing Pakistan's default in the months leading up to the SBA. Between January and June 2023, Pakistan faced the repayment of $3.5 billion in maturing commercial loans to Beijing, as well as the return of $5 billion in loaned foreign exchange reserves, including $3 billion to China. China rolled over and refinanced almost $7 billion, easing Pakistan's critical debt obligations.

Saudi Arabia and the UAE also came to Pakistan's aid during this crucial juncture. Both Sharif and the country’s Army Chief General Asim Munir met Saudi Crown Prince Mohammad bin Salman and UAE ruler Mohammad bin Zayed to seek financial assistance. Subsequently, Saudi Arabia and the UAE pledged $2 billion and $1 billion, respectively, contingent on the revival of the IMF program. When Pakistan finalized the deal with the IMF in July, Saudi Arabia and the UAE released the promised funds, playing a pivotal role in rescuing Pakistan's economy from the brink.

Economic Recovery Challenges

The IMF program and financial support from Saudi Arabia, the UAE and China have opened a path to economic recovery for Pakistan. However, the economic situation remains fragile with several challenges that, if not managed correctly, can push Pakistan toward deeper economic turmoil. Three major challenges await Pakistani policymakers: implementing politically difficult and inflation inducing measures to complete the current short-term IMF program, negotiating a new IMF program next year and finalizing investment agreements with Arab Gulf nations.

1. Managing Political Pressure of Current IMF Program

Pakistan’s current $3 billion IMF program is a short-term arrangement, requiring unpopular yet inescapable economic policy changes. For example, the IMF wants Pakistan to float its exchange rate in a way that narrows the difference between the interbank and open market exchange rate, which is causing significant rupee depreciation against the dollar and adding to inflation. Pakistan also needs to cut financial losses of its hemorrhaging energy sector by increasing power tariffs, which is making electricity unaffordable for many Pakistanis. These adjustments will amplify the impact of Pakistan’s fiscal indiscipline: the Pakistani government continues to run large deficits and finances them by excessive printing of the Pakistani rupee, adding to inflation.

Due to the combination of necessary IMF adjustments and Pakistan’s policy missteps, another wave of inflation is likely to hit the country. Reports indicate protests and growing discontent across the nation due to rising prices, which will put pressure on the government to backtrack on these adjustments.

2. Negotiating a New IMF Program

To secure a new IMF program Pakistan needs to commit to economic reform, but political factors are equally critical. The country was supposed to hold an election no later than November of this year. But due to a delayed decision by the former government and the Election Commission to redraw electoral boundaries based on a recently held census, there is significant uncertainty over the timing. The country now has an interim government which does not have a legal mandate to sign a new deal with the IMF. The IMF is also unlikely to conclude a new program with an interim government. Pakistan’s current IMF program is supposed to conclude in early April. Therefore, if the election is not held by February or March 2024, negotiations over a new IMF program may hit a dead-end. A prolonged stand-off with the IMF will once against push Pakistan toward a default-like situation.  

3. Securing Investment from the Gulf

Pakistan’s financing needs for next few years are such that IMF alone will not be enough to come out of the economic crisis. Aware of this challenge, Pakistani leaders are trying to secure investment from Gulf powers to generate cash and spur economic activity in the country — and claiming that Saudi Arabia and UAE are ready to invest tens of billions of dollars.

Pakistan has established a military dominated body to manage major economic projects in the country — the Special Investment Facilitation Council (SIFC). Comprising the prime minister and army chief, the SIFC aims to bolster investor confidence and expedite project implementation. The council has greenlit 28 investment projects, valued at billions of dollars, to pitch to Gulf nations. Pakistan is also trying to sell equity in the Reko Diq mines, one of the world’s largest reserves of gold and copper, to Saudi Arabia. Other plans include outsourcing management of airports to the UAE, privatizing the national airline on an accelerated timeline, and expediting a free trade agreement with the UAE, referred to as the Comprehensive Economic Partnership Act.

However, these initiatives could be hindered by persistent challenges that investors in Pakistan have long encountered, such as bureaucratic inefficiencies, concerns about shifting economic policies, an unfavorable business environment and ongoing political instability. In addition, there are concerns about potential long-term liabilities, like outbound dividend flows, of some investment schemes pressuring the country's balance of payments. Hasty trade agreements, such as the China-Pakistan Free Trade Agreement, have tilted trade balances unfavorably besides eroding the manufacturing sector in the past, so there might be objections to the free trade agreement with the UAE as well.  

International Politics of Pakistan’s Economic Recovery

Pakistan’s economic recovery not only requires prudent economic choices but also strong political relations with several external powers with competing interests. For one, the UAE and Saudi Arabia are likely to invest in Pakistan not just for economic return but also for influence, requiring Pakistan to be more sensitive to their concerns and interests. The leverage of both countries on Pakistan has always been considerable but it is rising even more.

It also requires keeping the Chinese happy. Pakistan’s ongoing efforts to secure financing from the Saudis and Emiratis — if successful — may end up eclipsing Chinese economic influence, but Pakistani leaders will still need to retain the goodwill of the Chinese to manage external debt repayment pressure, especially as a significant amount of Pakistan’s commercial debt is owed to Chinese institutions. Finally, Pakistan will need to maintain a good relationship with the United States — at the least for getting the next IMF deal cleared through the IMF board, where the United States remains the largest share of vote.

How Pakistan plans to manage the cross-cutting and at times conflicting imperatives that will arise in dealings with these countries is unclear. Pakistani authorities are downplaying the potential of regional stakeholders pulling them in different directions. They are assuming that the investments coming from the Gulf will supplement Beijing’s China-Pakistan Economic Corridor and the two will not be in competition with one another. They also believe they can continue to balance between Chinese expectations and the United States.

The country’s economic recovery effort remains a steep challenge.

Shahbaz Rana is an economic correspondent with Pakistan’s daily English newspaper The Express Tribune and the host of a primetime TV show, The Review, at Express News.

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