Pakistan's Economic Crisis: An In-Depth Analysis and Path to Recovery

Category: Economy

Pakistan is grappling with significant economic challenges, including a high Debt to GDP ratio, an increasing money supply, and rising fiscal deficits. The country's economic situation is further exacerbated by inflationary pressures and a struggling public sector. Effective fiscal discipline, tax reforms, and investment in human capital are critical to navigating these issues. By addressing these challenges through strategic reforms and prudent economic policies, Pakistan can pave the way for sustainable economic growth and stability. Let's explore together the major reasons of this crisis and a possible candid solution.

1. Money Supply Growth

The amount of money in circulation in Pakistan increased by about 492.51% from June 2020 to June 2024.

• In June 2020, there was 6.14 trillion PKR in circulation.
• By June 2024, this had grown to 36.4 trillion PKR.

How is the Money Supply Increased by this Much?

The money supply can be increased in several ways:

• Central Bank Actions: The State Bank of Pakistan (SBP), like other central banks, can print more money or use electronic means to add money to the economy.
• Government Borrowing: The government can borrow money from the central bank or other financial institutions, which increases the money circulating in the economy.
• Loans: When banks give out loans, they essentially create new money because the money lent out gets deposited and re-loaned, multiplying the amount of money in circulation. This is also called Fractional Reserve Lending and allows banks to create credit thus increasing overall money supply in the economy.

2. GDP Growth Rates (2019-2024):

GDP (Gross Domestic Product) is the total value of all goods and services produced within a country in a specific period.

In 2019, Pakistan's GDP was approximately $320.9 billion USD. Following are the percentage increase or decrease in GDP growth from previous year:

• 2019: 3.12%
• 2020: -0.94% (estimated GDP: 317.88 billion USD)
• 2021: 5.77% (estimated GDP: 336.19 billion USD)
• 2022: 6.17% (estimated GDP: 357.93 billion USD)
• 2023: -0.17% (estimated GDP: 357.32 billion USD)
• 2024: 2% (projected GDP: 364.47 billion USD)

Why Didn't the Economy Grow Despite the Massive Increase in Money Supply?

There are several reasons to explain this:

• Inflation: When the money supply increases too quickly, it can lead to inflation, where prices of goods and services go up. This can erode purchasing power, and people can buy less with the same amount of money. Essentially, this acts as a hidden tax on everyone.
• Inefficient Spending: If the additional money is not spent on productive activities (like building infrastructure or improving education), it might not contribute to economic growth which leads to inflation.
• Economic Uncertainty: Political instability, poor governance, or global economic conditions can affect confidence and investment, preventing growth despite more money being available. Which is very much the case with Pakistan.

3. Government Budget:

• From July 2023 to March 2024, the government spent more than it earned, resulting in a deficit of 3.7% of the total economy (about 3,902.416 billion PKR).
• However, provincial governments saved about 403.401 billion PKR.
• For the next year (2024-25), the government expects to spend more than it earns, with a deficit target of 6.9% of the total economy.

How is the Government Able to Spend More Money than It Earns?

Governments can spend more than they earn through:

• Borrowing: The government borrows money from domestic (local) and international lenders. This can include banks, other countries, or international organizations like the IMF.
• Issuing Bonds: The government issues bonds, which are like IOUs. Investors buy these bonds, giving the government money now in exchange for a promise to pay back the money with interest in the future. This is essentially borrowing money from the future, and eventually, taxpayers (Pakistani Citizens esp middle and lower class) will have to repay this borrowed money through taxes.
• Deficit Financing: The central bank (SBP) can print more money to cover the deficit, though this can lead to inflation if overdone.

Where Does the Money Come From If It Doesn't Exist in the Economy?

When the government borrows or the central bank (SBP) prints more money, new money is introduced into the economy. This doesn't mean the money physically exists beforehand; it's created through financial mechanisms like loans or bond issuance. Simply, money coming out of thin air. Issuers benefit by accessing the money first for purchases or investments, but citizens face inflation as the increased money circulates widely, reducing its value as money demand outstrips goods supply.

4. National Debt:

• As of June 2023, Pakistan's total debt was 62.881 trillion PKR (US$223.86 billion), which is 74.3% of the total economy.
• The government owes 24.309 trillion PKR (US$87.24 billion) to domestic creditors.
• Public sector companies owe 1.67 trillion PKR (US$6 billion).

How Domestic Creditors and Public Sector Companies Fund the Government?

Domestic creditors and public sector companies can lend money to the government, but there are limits:

• Domestic Creditors: These are often banks, pension funds, or other financial institutions that have large amounts of money saved or invested.
• Public Sector Companies: These companies may have profits that they can use to lend to the government, but they are not typically a primary source of government funding.

5. Economic Implications:

• Higher Prices: More money in circulation can lead to higher prices for goods and services.
• Weaker Currency: With more money around and ongoing deficits, the value of the currency might decrease.
• Higher Interest Rates: The central bank might raise interest rates to control rising prices, making loans more expensive. As of July 15, 2024, the State Bank of Pakistan's (SBP) policy rate is 20.50% per annum. This is the rate at which the SBP lends money to commercial banks.
• Economic Growth: While increasing the money supply can boost the economy in the short term, it might cause long-term problems if not managed well. The GDP clearly reflects long-term problems as the growth is almost negligible as compared to money supply.
• Debt Concerns: High debt levels and rising deficits highlight the need for careful financial management and structural reforms to ensure long-term economic stability.

6. Candid Solutions for Quick Structural Reforms:

Here are some candid solutions for structural reforms that could help address Pakistan's economic challenges, particularly regarding high debt levels and rising deficits:

1. Fiscal Discipline and Transparency:
   • Implement strict fiscal discipline to reduce government spending and prioritize essential expenditures.
   • Enhance transparency in budgetary allocations and spending to minimize corruption and mismanagement.
2. Tax Reforms:
   • Broaden the tax base to increase revenue collection without burdening a small segment of the population.
   • Simplify tax laws and procedures to improve compliance and reduce tax evasion.
3. Public Sector Reforms:
   • Improve the efficiency and accountability of public sector enterprises to reduce financial losses and improve service delivery.
   • Consider privatization or public-private partnerships for sectors where government involvement is less efficient.
4. Monetary Policy and Inflation Control:
   • Strengthen the independence and effectiveness of the State Bank of Pakistan in setting monetary policy.
   • Focus on controlling inflation through prudent monetary measures to stabilize prices and protect purchasing power.
5. Investment in Human Capital:
   • Enhance investment in education, healthcare, and skills development to improve productivity and economic competitiveness.
   • Foster an environment conducive to entrepreneurship and innovation to stimulate economic growth.
6. Infrastructure Development:
   • Prioritize infrastructure projects that can boost economic activity and improve connectivity within the country and regionally.
   • Ensure transparency and efficiency in infrastructure investments to maximize returns and minimize costs.
7. Debt Management and Sustainability:
   • Develop a comprehensive debt management strategy to ensure sustainable borrowing and repayment capabilities.
   • Negotiate favorable terms for external debt and prioritize investments that generate economic returns to service debt obligations.
8. Sectoral Reforms:
   • Undertake reforms in key sectors such as agriculture, energy, and industry to enhance productivity, competitiveness, and sustainability.
   • Address structural bottlenecks and regulatory hurdles that hinder sectoral growth and investment.
9. Governance and Institutional Strengthening:
   • Strengthen governance frameworks, rule of law, and institutions to improve public trust, investor confidence, and economic stability.
   • Enhance capacity building and training for public officials to improve policy making and implementation.
10. Regional and Global Integration:
    • Actively engage in regional economic integration initiatives to expand trade opportunities and attract foreign investment.
    • Foster partnerships with neighboring countries and international organizations to leverage resources and expertise for economic development.

Implementing these structural reforms will require political will, consensus-building among stakeholders, and sustained commitment to long-term economic stability and growth. Each reform area addresses specific challenges and aims to create a more resilient and prosperous economic environment for Pakistan.

At the end the most important question. Even after these Structural Reforms, is the Debt system designed to function in a prosperous way? More articles coming soon on this Debt System in Finance category. Stay Tuned!