Even though the Pakistani government now appears to recognize its debt problem, it has failed to acknowledge the severity of the situation. Instead of seeking a debt reprofiling or taking yet another loan from the IMF, the country must undertake a preemptive restructuring to address its deep-seated economic weaknesses.
NEW DELHI – In July, Pakistan reached a staff-level agreement with the International Monetary Fund on a record 25th program, in yet another attempt to kick-start economic growth and development as the country lurches from crisis to crisis. But the new IMF program, which will likely be finalized once Pakistan secures “adequate” assurances from major creditors that its outstanding loans will be rolled over, fails to address a much more fundamental problem: the country’s unsustainable debt.
Interest payments on public debt consumed an estimated 68% of Pakistan’s revenue in the 2022-23 fiscal year, and its debt-to-GDP ratio was more than 80%, compared to less than 40% in Bangladesh, which gained independence from Pakistan in 1971. The IMF estimates the country’s total external-financing needs will total roughly $128 billion over the next five years, with every year’s needs exceeding even optimistic forecasts of its foreign reserves. To restore debt sustainability, Pakistan would need to restructure its internal and external obligations, as Sri Lanka is currently doing.
Pakistan’s deep-seated problems, including entrenched business elites, a persistent democracy deficit, and the military’s outsize economic role, have undermined market credibility, investment, and GDP growth. High levels of non-transparent protection have resulted in stagnant exports – $35.2 billion in 2023, compared to Bangladesh’s $57.6 billion – and recurrent foreign-exchange crises. Investment spending amounted to only 12% of GDP in 2023, compared to 31% in Bangladesh and neighboring India, and GDP per capita was 56% of Bangladesh’s.
The current crisis reflects these underlying problems. Accumulated economic imbalances, both fiscal and external, fueled inflation and contributed to rising debt levels in 2022, with massive floods only exacerbating the situation. That year, the government had to scramble to arrange $33.7 billion in external financing, with reserves falling to $9.8 billion.
Addressing these problems requires debt restructuring (ideally preemptive, rather than post-default, because this leads to better outcomes for debtors, creditors, and the economy). A World Bank study of 177 sovereign external and domestic debt defaults found that five years after successful defaults, governments had reduced their debt-to-GDP ratio by 24-34 percentage points, and effective interest rates on government debt had fallen by as much as two percentage points. Consider Sri Lanka’s gradual return to positive growth and increased market optimism after defaulting in April 2022: its ten-year government bond yield was 13.3% on August 30, 2024, compared to 32% in November 2022.
To be sure, debt restructuring is never easy, and Pakistan will confront two major challenges if it chooses this route. First, domestic debt accounts for the bulk of the government’s obligations, equivalent to 46% of GDP in 2023, whereas external debt was 29% of GDP (excluding IMF obligations and debt guarantees). Any meaningful restructuring would thus require domestic debt holders – mainly local banks – to take a haircut, which could pose political problems and raise concerns about financial stability. Fortunately, local banks’ high profitability provides some room for maneuver.
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Second, Pakistan’s biggest creditor is China, which holds more than 28% of the country’s total external public debt (even more than the World Bank). Given that China has proven to be a reluctant participant in sovereign-debt restructurings, this could be a significant impediment. Sri Lanka’s recent restructuring agreement with China’s Exim Bank, however, suggests a greater willingness on China’s part to resolve global debt issues.
The Pakistani government now appears to recognize that it has a debt problem, even as it fails to acknowledge the severity of the situation. Prime Minister Shehbaz Sharif recently wrote to China requesting a debt reprofiling, which would involve extending the maturity period of existing debt and reducing interest rates. (This differs from the debt rollovers that the government continues to seek from multiple countries, including Saudi Arabia, the United Arab Emirates, and China, and which imply securing new debt on the same terms.)
But the proposed reprofiling would hardly make a dent in Pakistan’s external-financing needs, because it would address only the debt owed to Chinese power producers. Moreover, each energy project could be negotiated separately, which would further prolong a notoriously protracted process. In fact, there is a good chance that China will deny Pakistan’s request, as it has shown a strong preference for fair burden-sharing among all creditors.
Rather than delay the reckoning, Pakistan should overcome its fears and ask the IMF to help prepare an orderly debt-restructuring program. To set itself on the road toward sustained growth, the government must be willing to implement fundamental reforms such as raising taxes, renouncing the anti-export bias in its trade policies, and improving public-expenditure management. This will requireovercoming the resistance of corporate leaders.
This path is hard and long. But the alternative is worse: a possible disorderly debt default, and continued trips to China, Saudi Arabia, the UAE, and the US seeking bailouts, would condemn Pakistan’s economy to years of slow and volatile growth, performing well below its potential.
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NEW DELHI – In July, Pakistan reached a staff-level agreement with the International Monetary Fund on a record 25th program, in yet another attempt to kick-start economic growth and development as the country lurches from crisis to crisis. But the new IMF program, which will likely be finalized once Pakistan secures “adequate” assurances from major creditors that its outstanding loans will be rolled over, fails to address a much more fundamental problem: the country’s unsustainable debt.
Interest payments on public debt consumed an estimated 68% of Pakistan’s revenue in the 2022-23 fiscal year, and its debt-to-GDP ratio was more than 80%, compared to less than 40% in Bangladesh, which gained independence from Pakistan in 1971. The IMF estimates the country’s total external-financing needs will total roughly $128 billion over the next five years, with every year’s needs exceeding even optimistic forecasts of its foreign reserves. To restore debt sustainability, Pakistan would need to restructure its internal and external obligations, as Sri Lanka is currently doing.
Pakistan’s deep-seated problems, including entrenched business elites, a persistent democracy deficit, and the military’s outsize economic role, have undermined market credibility, investment, and GDP growth. High levels of non-transparent protection have resulted in stagnant exports – $35.2 billion in 2023, compared to Bangladesh’s $57.6 billion – and recurrent foreign-exchange crises. Investment spending amounted to only 12% of GDP in 2023, compared to 31% in Bangladesh and neighboring India, and GDP per capita was 56% of Bangladesh’s.
The current crisis reflects these underlying problems. Accumulated economic imbalances, both fiscal and external, fueled inflation and contributed to rising debt levels in 2022, with massive floods only exacerbating the situation. That year, the government had to scramble to arrange $33.7 billion in external financing, with reserves falling to $9.8 billion.
Addressing these problems requires debt restructuring (ideally preemptive, rather than post-default, because this leads to better outcomes for debtors, creditors, and the economy). A World Bank study of 177 sovereign external and domestic debt defaults found that five years after successful defaults, governments had reduced their debt-to-GDP ratio by 24-34 percentage points, and effective interest rates on government debt had fallen by as much as two percentage points. Consider Sri Lanka’s gradual return to positive growth and increased market optimism after defaulting in April 2022: its ten-year government bond yield was 13.3% on August 30, 2024, compared to 32% in November 2022.
To be sure, debt restructuring is never easy, and Pakistan will confront two major challenges if it chooses this route. First, domestic debt accounts for the bulk of the government’s obligations, equivalent to 46% of GDP in 2023, whereas external debt was 29% of GDP (excluding IMF obligations and debt guarantees). Any meaningful restructuring would thus require domestic debt holders – mainly local banks – to take a haircut, which could pose political problems and raise concerns about financial stability. Fortunately, local banks’ high profitability provides some room for maneuver.
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Watch our Climate Week NYC 2024 event now to hear speakers from across the globe – including Mia Amor Mottley, Prime Minister of Barbados; Gabriel Boric, President of Chile; Jiwoh Abdulai, Minister of Environment and Climate Change of Sierra Leone; and Maisa Rojas Corradi, Minister of the Environment of Chile – discuss climate leadership, development finance, and more.
Watch Now
Second, Pakistan’s biggest creditor is China, which holds more than 28% of the country’s total external public debt (even more than the World Bank). Given that China has proven to be a reluctant participant in sovereign-debt restructurings, this could be a significant impediment. Sri Lanka’s recent restructuring agreement with China’s Exim Bank, however, suggests a greater willingness on China’s part to resolve global debt issues.
The Pakistani government now appears to recognize that it has a debt problem, even as it fails to acknowledge the severity of the situation. Prime Minister Shehbaz Sharif recently wrote to China requesting a debt reprofiling, which would involve extending the maturity period of existing debt and reducing interest rates. (This differs from the debt rollovers that the government continues to seek from multiple countries, including Saudi Arabia, the United Arab Emirates, and China, and which imply securing new debt on the same terms.)
But the proposed reprofiling would hardly make a dent in Pakistan’s external-financing needs, because it would address only the debt owed to Chinese power producers. Moreover, each energy project could be negotiated separately, which would further prolong a notoriously protracted process. In fact, there is a good chance that China will deny Pakistan’s request, as it has shown a strong preference for fair burden-sharing among all creditors.
Rather than delay the reckoning, Pakistan should overcome its fears and ask the IMF to help prepare an orderly debt-restructuring program. To set itself on the road toward sustained growth, the government must be willing to implement fundamental reforms such as raising taxes, renouncing the anti-export bias in its trade policies, and improving public-expenditure management. This will require overcoming the resistance of corporate leaders.
This path is hard and long. But the alternative is worse: a possible disorderly debt default, and continued trips to China, Saudi Arabia, the UAE, and the US seeking bailouts, would condemn Pakistan’s economy to years of slow and volatile growth, performing well below its potential.