Pakistan Economic Crisis: An Explainer

A recent video of Pakistani civilians struggling for food grains has captured the front page of everyone’s browsers. The sorry state of the people fighting tooth and nail for the bare minimum was not a pleasant sight.

The price of various staples has gone up to shocking levels, with essentials like onions, rice and eggs going up to 215, 145 (per kilogram) and 400 Pakistani rupees (PKR). With the prevalent exchange rates, people might think that these prices are in line with India’s economy too; but conversion reveals that under similar economic circumstances, the same edibles would cost ₹75, ₹145 (per kilogram) and ₹141.

So what went wrong with Pakistan, and why has India’s neighbour from the north fallen on such tough times? In a typical “what is wrong with the neighbour?” fashion, let us take a look at Pakistan and the deconstruction of its most recent economic crisis.

What are the Four Major Economic Problems in Pakistan?

Pakistan’s economic troubles can be broken down into four macroeconomic facets. These aspects of the economy together have the potential to send Pakistan into a spiral of economic downfall. What’s worse, these aspects have something of a domino effect that triggers the others, initiating a vicious cycle.

The four factors bringing about Pakistan’s current downfall are as follows:

Currency Depreciation

Pakistan has had a rocky political environment, owing to which it has failed to be an international investment avenue. The political instability is a result of the ruling party never being able to even finish its term!

A negative by-product of an unstable political system is a constantly fluctuating financial system. Militant coups and the most recent no-confidence vote against ruling prime minister Imran Khan show just how poorly the country’s political system work. New parties would constantly try to undo the previous party’s decisions to prove their mettle, and there would be no forward momentum.

Pakistan also primarily depends on imports for its food supply and, as a result, is a net importer of merchandise. This resulted in a trade deficit which reached an all-time high of $44.7 billion in FY22.

Constant trade deficits result in the country using foreign currency more to buy foreign merchandise. This results in a fall in its demand, and as a result, the value of the domestic currency (PKR in this case) falls.

And when the value of a currency falls (like my ability to comprehend global transactions by the end of the day), prices rise. This leads us to the next problem.

Rising Inflation

Inflation may lead to a rise in prices in an economy, but a rate of 4% to 6% is actually considered healthy for most economies. This constant rise in price acts as a stick poking the economy to keep up with the rising demands of a growing population.

However, when kept unchecked, inflation rates may rise beyond control and do more harm than good to the economy. As seen in the case of Pakistan, the fall in the value of PKR caused its domestic purchasing power to fall, leading to a rise in the price of all commodities across the economy.

So the unreasonable prices for essential commodities mentioned above come as a result of both internal and external flaws in Pakistan’s economy.

The falling purchasing power of the currency also raises the price of goods that the economy imports. This is because more units of the domestic currency are required to buy an unchanged amount of foreign merchandise.

The annual rate of inflation in Pakistan currently stands at 12%, with the monthly inflation soaring as high as 23% in urban settings and 29% in rural areas for September 2022.

The rising inflation and trade deficit keep feeding each other with staples like even tea, reaching import spending of close to $617 million (~2% of the 2022 GDP). No wonder even ministers go on public record to urge people to drink less tea.

Rising Fuel Prices

Similarly to India, Pakistan imports the majority of its fuel from foreign sources. In the case of Pakistan, the supplier of oil for Pakistan is Qatar. The fall in the value of PKR made fuel prices rise as it became costlier to import fuel among other foreign merchandise.

Since fuel is a key input to all industries, the rise in fuel prices increased the cost of production across the economy. This increase in cost was reflected in rising prices of intermediate as well as finished goods. Thus, rising fuel prices led to an increase in inflation, which worsened foreign trade and further exacerbated the inflation problem.

Depleting Foreign Reserves

With the value of PKR falling, and imports to Pakistan rising, the outcome is a rising deficit of foreign reserves. This happens because more PKR is spent to import the same amount of merchandise from foreign economies.

Top the increasing rate to buy with increasing purchases, the foreign reserves that Pakistan holds deplete at an incremental rate. Pakistan’s foreign reserves stand at $6.7 billion. As it stands, Pakistan’s current reserve can afford just 3-5 weeks of imports. After that, times might be bleak for the country.

The Bottom Line

It is a very “Indian” mentality to peek at the neighbour’s lawn whenever some mishap happens. However, owing to the animosity between the countries, India has not participated in helping its northwestern neighbour.

Multiple countries have come together and pooled $10 billion to help Pakistan in this time of need. The fund mentioned will act as a donation and will not be an addition to the country’s already mounting debt that Pakistan is already struggling to repay.