he national economy is in troubled waters. The fact that analogies are being drawn between Pakistan and Sri Lanka should be sobering for all Pakistanis. Conventional wisdom suggests that when economies face difficulties the respective stock markets are the first to react. By this standard, the recent meltdown of Pakistan Stock Exchange (a 2.23 percent fall in the KSE-100 index in a single day) is an unmistakable indicator that there is something fundamentally wrong with Pakistan’s economy.

In a related development, the rupee has been in a virtual free fall. On Thursday, US dollar traded at an unprecedented level of Rs 192.20. Closely related to these developments are a high degree of indebtedness, a sharp increase in the global commodity prices and a widening trade gap that has hit Pakistan’s economy hard.

So, what has gone wrong with Pakistan’s economy? Apparently, there is no simple explanation. A complex set of deep-seated structural issues has been hurting Pakistan’s economy for quite some time. Though there is a lot of overlap in the factors influencing the economy, we can analyse some of these factors in isolation without much loss of generality.

The most crucial question is why the Pakistani rupee has been in freefall for four years and whether it is possible to arrest the trend. For starters, the value of a currency is intrinsically linked to the magnitude of the foreign exchange reserves and the gap between exports and imports. In the recent past, Pakistan has been in a challenging situation in terms of forex reserves.

The State Bank’s foreign exchange reserves have dropped to around $10 billion and the current account deficit has reached $13 billion. According to another estimate, Pakistan’s trade deficit has crossed $39 billion in the first ten months of the current fiscal year and the volume of imports has grown at double the rate of growth in exports. A combination of depleting forex reserves and widening trade gap has put the national currency under pressure, fuelled inflation and forced the government to hike the interest rates to arrest inflationary trends.

External factors are significantly exacerbating Pakistan’s economic problems. The slowdown in several large economies and higher oil prices resulting from the Russian invasion of Ukraine have also contributed to rising global commodity prices and, in turn, a rise in inflation and devaluation of the Pakistani rupee against the dollar.

A high degree of indebtedness has also dented Pakistan’s economy. Pakistan’s external debt has averaged $65.223 billion from 2002 until 2021, reaching an all-time high of $130.632 billion in the fourth quarter of 2021. In relative terms, Pakistan’s external debt was around 26 percent of its GDP in 2014, dropping to 23.5 percent in 2016 and increasing to 26.7 percent in 2018. It shot to 33 percent in 2019 and peaked at 37.6 percent in 2020.

Political exigencies lie at the heart of the government’s dithering. Every increase in commodity prices will be fodder for Imran Khan’s drive for early elections. Staying the course, on the other hand, will further increase the fiscal deficit leading to greater indebtedness.

There are competing arguments regarding the impact of public debt. One argument is that indebtedness makes Pakistan extremely vulnerable to economic shocks, weakens it vis-a-vis external lenders and has significantly compromised its ability to invest in education and healthcare. An alternative view is that the debt to GDP ratio may be irrelevant to the requirements of economic stability. Recent estimates show interesting patterns of debt to GDP ratios around the world. According to the most recent data, the debt to GDP ratio is 117 percent in Australia, 161 percent in Austria, 204 percent in Finland and a whopping 685 percent in Ireland. On the other hand, even small debt to GDP ratios can overwhelm some economies.

It is almost a truism that the burden of inflation is shared unequally by different wealth groups. The poor bear the brunt of inflation. Disturbingly, the poor and vulnerable population groups in Pakistan are expected to continue to suffer because there does not seem to be any immediate let up in the inflationary trends as the trade deficit is expected to reach $50 billion by the end of this fiscal year.

Another factor hurting the economy is the widening budgetary deficit. It has been ballooning recently, particularly in the first three quarters of the current fiscal year, primarily because of the chosen revenue generation model.

Pakistan raises revenues in two forms: tax and non-tax. The FBR is primarily responsible for raising tax revenues and has been relatively successful in meeting its target of revenue collection, registering a growth rate of 28 percent in the first three-quarters of the current fiscal year. However, it will be difficult for it to sustain the growth because the government is under pressure to limit the imports.

As against an increase in the tax revenue, there has been a significant decline in the non-tax revenue. The petroleum levy had traditionally made a sizable part of the non-tax revenue pie. Only 20 percent of Rs 620 billion target has been collected in the first nine months of the current fiscal year, with little hope of a significant growth in the last quarter. Consequently, the economy will be under more stress.

It may be instructive to see how politics affect the economy and vice versa. The current government is inherently unstable. The political situation has left the incumbent regime little clarity regarding the duration of its stint in power. The uncertainty is harmful to the process of economic recovery. The government is in a proverbial dilemma: “to call or not to call elections right away.” A miscalculation may prove fatal for the coalition.

The way the government has conducted its affairs has also been unsettling for the economy. After a brief period of optimism that the PML-N led coalition will turn the economy around, the emerging view is that the current regime is clueless. It has been unable to put its act together and take actions necessary to avert an economic collapse. Meanwhile, the former prime minister has mounted a formidable political challenge to it.

The fact that the regime also suffers from internal contradictions has not helped. The International Monetary Fund wants the government to roll back fuel subsidies and tax exemptions. The government sees the subsidies announced by the previous government as “landmines” laid deliberately once the former prime minister saw the writing on the wall.

However, the government itself has no clear vision. According to some reports, Ishaq Dar, the former finance minister, has strongly opposed the IMF terms. When clarity about who is calling the shots and where the buck stops is lacking, the economy suffers. This is especially true because financial support from “brotherly Islamic countries” and other “friendly” countries does not seem to be forthcoming without the IMF nod. Additionally, investors’ confidence is eroding. A significant capital flight will further complicate the situation for Pakistan.

Political exigencies lie at the heart of the dithering. Every increase in commodity prices will be fodder for Imran Khan’s drive for early elections. On the other hand, staying the course will increase the fiscal deficit leading to higher indebtedness, higher interest rates and more economic chaos. The government seems to be between a rock and a hard place. It may be forced to phase out energy subsidies as a hedge against a possible Sri Lanka-like default.

The writer is an associate professor in the Department of Economics at COMSATS University Islamabad, Lahore Campus