The Looming Crisis

By: Dr. Hafiz A. Pasha
Published: December 1, 2017
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Uncertainty is at its peak today in Pakistan. This uncertainty predominantly has four dimensions – political, economic, security and foreign relations.

Seldom in the country’s history have all these negative developments occurred, more or less, at the same time. On the political front, the government appears to have lost the fiat and willingness for implementing strong policy actions. There are also concerns whether democracy will proceed normally up to the national election.

The economy faces an incipient financial crisis. Foreign exchange reserves are being depleted due to a burgeoning current account deficit in the balance of payments.

Efforts are being made to raise the high-cost, commercial debt internationally. This may not materialise due to growing doubts about Pakistan’s credit worthiness, or the interest costs may carry a large risk premium. This actually demonstrates the desperation to preserve the level of reserves.

Multinational companies have started remitting a higher share of profits and reserves to also benefit from the overvalued exchange rate


Security conditions had improved with the wide-ranging and strong actions taken by the military following the finalisation of the National Action Plan against terrorism and Zarb-e-Azb.

But attacks continue along the Line of Control (LoC). The situation had improved in Karachi, due to the clean-up operations by the Rangers, but the city is again in the grip of political confrontation and a higher incidence of crime.

Pakistan’s foreign relations are somewhat in a state of jeopardy. Relations with the US have soured following Washington’s demand to ‘do more.’ The regional situation in the context of Afghanistan has also become substantially more complicated.

Inevitably, this overriding uncertainty has triggered a reaction by economic factors. Speculative behavior has become more rampant.

One of the key elements of economic uncertainty is whether Pakistan is coming close to defaulting on its external obligations and thereby going into a full-fledged financial crisis. There is growing concern that Pakistan will have to, sooner or later, significantly devalue the rupee to bring down the extremely large trade deficit.

The objective of this article is to describe how hedging is taking place in various economic transactions, especially related to the inflow or outflow of foreign exchange. How this could be in the nature of a ‘self-fulfilling prophecy’ and could, in fact, precipitate a faster plunge into the financial crisis. Described below are different transactions which have already begun to be affected adversely.


 Importers face the prospect of a major rise in the value of the dollar with respect to the rupee, given that the currency is, at the moment, substantially overvalued by almost 25 percent. This has contributed to the big jump in imports.

This is the major factor responsible for the upsurge in the current account deficit of the external balance of payments, by 156 percent in 2016-17 and by 117 percent in the first quarter of 2017-18. Reserves have fallen in this quarter by as much as $2.3 billion. This fall in just one quarter compares with the annual decline in 2016-17 of $2 billion.

Issues of credit worthiness of Pakistan are clearly beginning to worry traditional lenders to Pakistan, especially the multilateral agencies

The process of importing more has probably led to a buildup of inventories. This has been facilitated by the presence of very low interest rates. The growth rate of imports of major items in the first quarter of 2017-18 is presented in Figure 1.

Imports of many items are up substantially at hitherto unprecedented rates. The growth rate ranges from 159 percent in the case of ships and aircraft, to 22 percent in imports of petroleum products and crude oil. Overall, total imports have increased by 25 percent. In the previous quarter, the growth rate was also recorded at a high of 27 percent.

Repatriation of profits

 Multinational companies have started remitting a higher share of profits and reserves to also benefit from the overvalued exchange rate.

During the first quarter of 2017-18 almost $427 million, equivalent to 28 percent higher profits and dividends, were sent abroad.


 There was a sudden drop of 20 percent in remittances in September 2017. Earlier, there had been some recovery. The fall can probably be attributed mostly to the increase in hawala transactions and diversion from the banking system.

The gap between the official and the open market exchange rate has widened by over Rs. 3 per dollar. There is a danger that the difference could widen further, especially as people are switching to foreign currency accounts by purchases from the open market. During the last six months, deposits in these accounts have increased by almost $800 million.

Over the full first quarter of 2017-18, there has been a decline in remittances from the largest source, Saudi Arabia, of 7 percent; 39 percent from Abu Dhabi and a marginal decline from Kuwait. Fortunately, remittances from the UK, the US and Dubai have held up in the first quarter.

Speculative behaviour has become more rampant. One of the key elements of economic uncertainty is whether Pakistan is coming close to defaulting on its external obligations and thereby going into a full-fledged financial crisis

Foreign portfolio investment

 A clear indication of heightened perceptions of risk and uncertainty is the plummeting of the stock market from June to September 2017.

The Pakistan Stock Exchange (PSE) index recorded a decline of over 16 percent by end-September as compared to the peak in May 2017. Market capitalisation of shares has been reduced by as much as $12 billion.

The consequence is that foreign investors have withdrawn $128 million from the market in the first quarter. This risk aversion was witnessed even earlier. Despite the strong performance of the PSE in 2016-17, over $500 million was withdrawn from Pakistan.

Foreign Direct Investment

 One of the few indicators which have shown strong performance in the first quarter of 2017-18 is foreign direct investment, registering a growth rate of 56 percent. However, 65 percent of the investment is from China, mostly in the power sector and construction, as part of the China Pakistan Economic Corridor (CPEC).

Other countries from which FDI has traditionally come to Pakistan have either lost some interest in Pakistan, or delayed their investment till such time their outlay in US dollars is worth more in rupees, following depreciation of the currency. Investment from the US has fallen by 67 percent, by 73 percent from the UK and by 6 percent from the EU countries.

Foreign assistance

 The upsurge in imports and the precipitous fall in foreign assistance are the two major areas of concern. There was a near zero net inflow from the multilateral agencies and bilateral sources in the first quarter of 2017-18. On one hand, gross disbursements are down by 27 percent.

On the other hand, the total repayment of external debt is up by 25 percent. It is not surprising that due to the combination of these two factors, foreign assistance virtually ceased, as compared to a net inflow of $785 million in the corresponding quarter of last year.

Issues of credit worthiness of Pakistan are clearly beginning to worry traditional lenders to Pakistan, especially the multilateral agencies. The gross inflow as a percentage of the target set for 2017-18, presumably based on past commitments, is given for each source in Figure 2.

Commercial borrowing has been taken on an emergency basis in the face of shortfalls from other sources. Almost half of the annual target for this source has already been met. Along with short-term financing from the IDB, the share in total gross borrowing is 53 percent.

Among the bilaterals, the largest borrowing is from China for CPEC infrastructure projects, although it is only 15 percent of the expected annual inflow. ADB, in particular, has disbursed only 10 percent of its annual target. Bonds, worth $1 billion, have not yet been floated.

Overall, the above trends clearly reveal the impact of uncertainty. There is a speculative upsurge in imports, faster repatriation of profits, exit from the PSE, perception of greater risk by foreign investors, with the exception of China, and reluctance to lend to Pakistan, with consequently greater reliance on high cost commercial borrowing.

If these behavioral tendencies persist or even intensify in the coming months, then the country may well be on the way to financial crisis by the end of the third quarter of 2017-18. Foreign exchange reserves could fall to a level not even adequate to provide import cover for two months.

Government functionaries continue to highlight the few positives of the economy to quell the growing perceptions of risk. Some policy actions have been taken like the imposition of regulatory duties mostly on luxury goods and the offer of an export incentive package.

However, stronger steps are required including a relatively big once-and-for-all depreciation of the currency. Otherwise, the on-going speculation could turn out to be a ‘self-fulfilling prophecy’, to the detriment of the people of Pakistan.

About the Author
Dr. Hafiz A. Pasha
is the dean of Beaconhouse National University and the vice chairman of the Institute of Public Policy. He is also serving as the chairman on the Advisory Panel of Economists to the Planning Commission and as the Convenor of the Economic Council of the PM.