A world in recession

The year 2022 was a tough year for the global economy, including Pakistan. The Ukraine war and the resultant decade-high food and energy inflation, extreme weather events, and worsening relations between the US and China kept adding to the world’s economic woes.

Higher interest rates in the US and the EU, which were imposed to control inflation, are slowing economic growth. Germany, the UK, and many other European countries will slide into recession this year. The simultaneous economic slowdown in the US, EU, and China will affect the rest of the world, and Pakistan is no exception.

How will the economy of Pakistan perform in 2023? To answer this question, one does not have to be a soothsayer. Economies worldwide, except oil-exporting Gulf countries, are in troubled waters. Managing Director IMF Kristalina Georgieva has warned that recession is here to stay for some time. She alerts that one-third of the world economy and half of the European Union will be in recession in 2023. It is safe to assume that like most economies, Pakistan will also remain in economic turmoil in 2023.

The intensity of that turmoil will be determined by the ongoing global trends and the presence (or absence) of certain factors or game-changers, and how they affect each other.

Take a look at the ongoing trends first: the Ukraine war is not nearing its end. Second, even if the war ends soon, the post-war world will witness new geopolitical alignments. Third, although tight monetary policies (higher interest rates) in the Global North will slow down the economies (recession) and tame inflation in the developed world, developing countries will remain afflicted by inflation for some more time. And finally, higher interest rates in rich countries will negatively impact investment flows and the value of local currencies in developing countries. These trends form the basis of the IMF’s global recession alert.

The impacts of these trends will be affected by the presence (or absence) of certain game-changers. China’s reopening to the world from January 8 (after having spent 1,016 days isolated from the outside world) which will mark the end of its zero-Covid policy is by far the biggest game-changer of 2023. Energy demand and prices during global recession are also important game-changers. Extreme weather events (climate change), the security situation vis-a-vis the TTP’s renewed attacks, and political stability are some of the Pakistan-specific game-changers.

Most defence analysts agree that Ukraine’s unprecedented resistance against the Russian invasion will compel Russia to use the ongoing winter months to prepare for fresh attacks on Ukraine in spring. Russia will try to prolong the war long enough to destroy Ukraine’s economy, sap its morale through strikes on civilian infrastructure and exhaust its partners. But Ukraine will have received the promised Patriot missile defence system from the US by then and may use it to sustain its resistance.

The best-case scenario is a negotiated ceasefire, providing both Russia and European allies with face-saving. In the worst-case scenario, Russia can use nuclear weapons, testing Nato’s patience. The unfolding of these scary events in 2023 will further weaken the already tumbling global economies, increasing the economic vulnerabilities of energy- and food-importing countries with low foreign exchange reserves (such as Pakistan).

Regardless of the fate of the war in Ukraine, one thing is for sure: the West will not trust Russia anymore. Economic decoupling between Europe and Russia, Europe and China, and the US and China is fast becoming a reality. After the Second World War, Germany was a strong proponent of reducing conflicts through economic dependencies. However, there are clear signals of a paradigm shift in Berlin. German President Frank-Walter Steinmeier recently said that, since the world has changed, “we must cast off old ways of thinking and old hopes, including the idea that ‘economic exchange will bring about political convergence’”. Steinmeier also thinks that “Berlin must learn from the past and reduce one-sided dependencies not just on Russia but also on China.”

Pakistan owes 30 per cent of its loans to China and nearly 20 per cent to Saudi Arabia. The US is its largest trade partner and strongly influences the IMF’s decision-making board. Also, the EU members will be deciding on the renewal of Pakistan’s preferential trading partner status in 2023. So far, Pakistan has managed to maintain a subtle balance in its relationship with all these major geo-economic powers. However, emerging geopolitical alignments would have a significant impact on Pakistan. In a ‘business-as-usual’ scenario, if Pakistan is not compelled to choose sides in an either-or form, it would avoid any risk of default. In the worst-case scenario, where Pakistan has to align with a bloc, it risks losing one or more important economic partners. Pakistan cannot afford this at present.

Higher interest rates in the US, an appreciated dollar, and recession in important economic partners will have a direct impact on Pakistan. The country is likely to see an increase in the cost of its domestic debt servicing, depreciation of the Pakistani rupee (making imports costlier), and an aggravated balance-of-payments crisis (due to low exports to and low remittances from the recession-hit trading partners).

The picture of Pakistan’s economy in 2023 in the context of global trends is not healthy. However, the story does not end here.

Let us consider how certain game-changers will impact Pakistan’s economic outlook. The reopening of China and the end of its zero-Covid policy will risk the spread of new Covid-19 variants. Combating any new pandemic wave while spending scarce resources on flood rehabilitation will be a massive challenge for Pakistan. However, in the medium to long run, Pakistan will also benefit from the reopening of the Chinese economy, especially if it can be part of the supply chains meeting China’s ‘post-zero Covid policy’ demand surge.

Depending on how quickly China’s new Covid variants peak, its energy demand will increase. However, global energy demand is generally expected to slow down in 2023 amidst the recession-war-pandemic situation. To avoid losses, OPEC and Russia may drastically limit production and increase prices. This step is likely to put Saudi Arabia and the UAE against the US.

If the US convinces OPEC countries not to reduce supplies drastically, Pakistan and many other oil-importing developing countries will be the beneficiaries of falling oil prices.

Climate change and extreme weather events are another game-changer for Pakistan’s economy. The heatwaves of 2022 have resulted in 25-30 per cent less wheat production in Pakistan. The floods of 2022 due to heavy monsoon rains have inflicted a cumulative loss and damage of $30 billion. Importing cotton to compensate for the 35 per cent loss of cotton production due to floods is an added burden on Pakistan’s scarce foreign exchange. A good or bad economic outlook for Pakistan in 2023 depends on the intensity and frequency of extreme weather events in the new year.

The fourth factor affecting Pakistan’s economy in 2023 is a renewed wave of terrorism. TTP militants are back with their nefarious agenda and have recently carried out several attacks. The earlier authorities deal with this situation either through stern military action or negotiations with the Afghan Taliban, the better it will be for Pakistan’s economy. A message that the country is a safe destination for investors and development partners cannot be conveyed effectively in the presence of elements like the TTP.

The final but most crucial factor determining the economic outlook for the year 2023 is political stability. Most factors and trends which are negatively affecting our economy are external. However, political stability is an internal factor and well within our control.

Without showing political maturity, we will remain in a vicious cycle of political instability, which will lead us to economic instability, further exacerbating poisonous politics, which is lethal to economic growth. This is a lose-lose scenario that no one in Pakistan would like to see. To avoid it, we should mend our ways.

The writer heads the Sustainable Development Policy Institute. He tweets @abidsuleri