he World Bank has documented four global recessions over the past 70 years: 1975, 1982, 1991 and 2009. Each occurrence witnessed a contraction of real per capita global GDP. This means that the incomes per person of countries around the world declined instead of improving.

Today, in 2022, the world finds itself on the brink of such an episode. The global economy has, since the advent of Covid-19, experienced several economic shocks, such as the abrupt halt of business activities during the early lockdowns starting in 2019 followed by a block on logistics movements and disruptions in global supply chains wherein shipments all over the world ground to a halt generating a slowdown in 2021. That has been followed by the Russia-Ukraine war in 2022 resulting in the largest refugee crisis in Europe since World War II, with a third of the Ukrainian population displaced.

As supply consistency and trade relations worsen, a coupling of inflation globally further exacerbates the risk of triggering a global recession episode. The IMF chief, Kristalina Georgiva has since said that the possibility “cannot be ruled out”.

While the global economy expanded by 6.1 percent in 2021, the IMF has downgraded its forecast for 2022 and 2023 set to be released later in July. Given the circumstances, countries like Pakistan are at an even higher risk.

While the large economies have the margin to reduce debts, diversify trading partners and weather interest rate hikes as the IMF suggests, Pakistan does not have the luxury.

The country barely avoids defaulting on its multitude of loans from various lenders. It lacks the ability to swiftly shuffle trading partners as the decision makers focus mostly on dealing with the US and China and avoid dealing with sanctioned countries.

As far as interest rates go, the State Bank of Pakistan’s policy rate currently stands at its highest in a decade (15 percent). Add to that the current sky-high inflation. The headline inflation stands at a whopping 21.35 percent, according to the Pakistan Bureau of Statistics data.

When the government earns less, debts will be even harder to pay, and important sectors, such as health and education get sacrificed to make fiscal space, in turn putting the citizens at the bottom of the barrel, at further risk. 

Pakistan finds itself in a very difficult situation where the high interest rate will discourage investments as cost of raising capital has drastically increased. One cannot therefore expect demands to be catered to.

In addition, the cost of operations has increased through an increase in fuel and raw material costs. Businesses thus have to choose between increasing prices and slimming down profit margins. Neither option is good for economic revival. One may argue that the increased interest rate is meant to reduce the supply of money and to encourage savings, in order to manage the dwindling value of the rupee. However, the continuous drop in the value of the rupee has shown the futility of the strategy.

Concurrently, the 10-year record-high inflation that did not accompany an appropriate raise in wage rates has resulted in a significant loss of buying power among Pakistanis. As the common citizen struggles to make ends meet, consumption of commodities has declined and savings are practically non-existent.

This reduction in buying power and the inability to save has drastically increased the cost of living. As Pakistani citizens consume less, the Pakistani state earns less revenue, since the government’s major source of revenue is the indirect taxation.

When the government earns less, the debts are even harder to pay, and important sectors, like health and education, get sacrificed to make fiscal space. In turn, this will put the citizens at the bottom of the barrel, at further risk.

Policy makers face crucial decisions over the coming months. They must steer the country through extremely difficult times, as a recession looms. It is clear that Pakistan cannot afford to further increase interest rates or follow the traditional means of making ends meet through loans and handouts. Neither will an increase in indirect taxes generate the needed revenues.

It is high time for the policy focus to devise a long-term solution that includes diversifying trade and trade partners, encouraging recurrent investments and reducing reliance on imports.

The writer is an NMF gold medalist and dean’s honour recipient from the Suleman Dawood School of Business at LUMS. He has a special interest in policy design and analysis