Faced with a projected $20 billion external financing gap, Pakistan is urgently seeking foreign exchange inflows as the new fiscal year begins on July 1. However, its long-standing ally, China, is hesitant to provide additional funds without guarantees of fool-proof security for its projects and workers in Pakistan.
Additionally, the US, with which Pakistan shares a complex relationship, is demanding decisive action against terror groups operating from across the Afghan border. Saudi Arabia and the UAE, two other key allies, also want to see significant improvements in Pakistan’s security environment.
All four countries are seeking assurances regarding the continuation of foreign investment policies before committing more state funds or encouraging their private sectors to invest in Pakistan’s agriculture, infrastructure, energy, mining, and IT sectors.
The US also desires a more inclusive democracy in Pakistan, while China wants to ensure that the policies of the current hybrid regime have the support of all political parties. Consequently, the hybrid regime is intensifying efforts to meet the various demands of these four nations through its policies and actions.
The government is prioritizing foreign support while neglecting the underlying causes of the growing balance of payments deficit.
Maintaining US support is crucial for securing sufficient funding from the International Monetary Fund (IMF), while winning over Chinese leadership is essential to advancing the second phase of the China-Pakistan Economic Corridor.
Similarly, maintaining good relations with Saudi Arabia and the UAE is necessary to rely on their financial assistance during foreign exchange crises. Both countries have a history of saving Pakistan from sovereign default by depositing billions of dollars in the State Bank and rolling them over when needed.
Understanding this context helps explain the current leadership’s efforts to forge political unity, even suggesting that terror groups operating from Afghanistan could be targeted within the country. Pakistan’s Defence Minister Khawaja Asif recently stated that such actions would not violate international law.
Moreover, Prime Minister Shahbaz Sharif has reiterated his willingness to engage with Imran Khan to achieve the political stability necessary to resolve the country’s crisis.
As of the week ending June 24, Pakistan’s central bank held just $8.9 billion in foreign exchange reserves, insufficient to cover two months of import bills. The repatriation in May of $918 million in dividends earned by foreign companies in Pakistan significantly reduced this amount, helping to clear a backlog accumulated over several quarters. This move aims to facilitate negotiations for a new IMF program to support the balance of payments (BoP) and signal to foreign investors that repatriating profits and dividends from Pakistan is now easier.
The federal budget for FY25 overlooks some IMF demands, including those related to government employees’ pay and pensions and the pace of subsidy withdrawals from the energy and food sectors. However, government officials hope to secure at least $7 billion in new IMF financing by the end of September, though no such assurance has been given, and discussions are ongoing.
The first quarter of the new fiscal year, July-September 2024, will likely test Pakistan’s ability to manage its external accounts. Even if a new IMF loan is approved by September, the first tranche would arrive either at the end of the month or early October. This means Pakistan must make all external debt payments independently while the trade deficit is likely to expand. Consequently, foreign exchange rates will be closely monitored.
State Bank of Pakistan data reveals that on June 27 this year, the rupee closed at Rs278.37 in the interbank market, an improvement from Rs285.99 a year earlier. However, it is uncertain if this trend will continue through July-September.
Between July 2023 and May 2024, Pakistan recorded a massive $21.82 billion trade deficit in goods and services. Fortunately, home remittances of $27.1 billion during this period exceeded the overall trade deficit, keeping the current account deficit manageable at $464 million in July-May of the last fiscal year.
Despite this low current account deficit, Pakistan’s overall BoP remained negative by $2.45 billion, even with $3 billion in IMF loans and billions in roll-overs from China, Saudi Arabia, and the UAE.
If exchange rates remain stable (as seen in FY24) despite a large BoP deficit but a low current account deficit, it suggests underlying issues with the exchange rate fundamentals. A low current account deficit, primarily achieved by stifling imports, may embolden authorities to maintain currency stability temporarily, ignoring the expanding BoP deficit.
However, this is not sustainable. A persistent BoP deficit will eventually impact the exchange rate; that time has come for Pakistan. In FY25, the rupee is likely to depreciate unless the underlying causes of the BoP deficit are addressed. It will also affect the current account deficit unless export growth outpaces import growth and remittances increase sufficiently to offset the rise in import volume.
