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Since Sri Lanka’s default on its foreign debt in May, the first in its history, there’s rising risk of similar defaults in other emerging market economies that don’t have the wherewithal to cope with the worsening global economic difficulties caused by Russia’s invasion of Ukraine coming on the heels of the shock of the pandemic. The next 12 months will be critical for most of these economies, as they try to somehow avert balance of payments crisis and loss of confidence.

Pakistan’s struggles are similar to these economies, although its problems are less severe than Sri Lanka’s. It also has recourse to lines of credit that could help it tide over the crisis.

Rising commodity prices, especially of crude, are widening Pakistan’s current account deficit, draining its foreign currency reserves and depreciating its currency. Last week, the Pakistani rupee saw the steepest weekly drop since 1998, after a regional poll predicted victory for former prime minister Imran Khan, just months after his ouster from the position.

The country’s central bank’s foreign exchange reserves have fallen by $7bn since February to just over $9bn, enough to cover just about a month and a half of imports. Inflation rose to 21.3 per cent in June, the highest level in nearly 13 years.

Fitch Ratings has downgraded its outlook for the country to negative from stable after a “significant deterioration in Pakistan’s external liquidity position and financing conditions since early 2022". Moody’s has downgraded its outlook for Pakistan to negative, and has raised concerns over the country’s ability to complete its current International Monetary Fund (IMF) programme, which, it said, “remains highly uncertain".

While Pakistan’s economy is vulnerable, its problems are slightly less severe than those of tourism-dependent Sri Lanka. The country is under an IMF loan programme since 2019. It hopes $1.3bn of new funding from its $7bn facility will be approved next month, easing its worsening liquidity crunch. In addition, it is also in talks with Saudi Arabia and China for funds.

In June, a consortium of state banks in China, Pakistan’s close military and economic ally, lent it $2.3bn to avoid a foreign payments default and helping it keep the IMF programme alive.

Pakistan’s debt vulnerability is of a different nature than that of Sri Lanka, which owes about 40% of its debt to commercial lenders. Pakistan has mostly borrowed from multilateral institutions, such as the IMF, and bilateral lenders, such as Chinese state banks.

Another difference is that Pakistan’s economic fragility can have altogether different geopolitical repercussions than the fallout of the economic collapse in Sri Lanka. Greater global resources are likely to be deployed to stave off a collapse of Pakistan’s economy, given the risks the country falling into crisis poses to the security and stability in the region.

Finally, Pakistan isn’t in political crisis, the way Sri Lanka is, where President Gotabaya Rajapaksa had to flee the country to escape the people’s fury. Still, political risks lurk in Pakistan—with implications for the viability of the IMF programme, especially the belt-tightening measures introduced by Pakistan’s government. The president of Pakistan Muslim League-Nawaz (PML-N), Shehbaz Sharif, was elected prime minister by parliament in April following the ousting of Khan-led Pakistan Tehreek-e-Insaf (PTI) government after the no-confidence motion in the National Assembly.

In response to mounting concerns that a $1.2bn loan disbursement from the IMF agreed this month might not be enough for tiding over the foreign exchange liquidity crisis, Pakistan’s central bank’s governor Murtaza Syed, who has experience of working for 16 years in the IMF, has told the Financial Times that the external financing needs to add up to about $34bn over the next 12 months which will be covered by the IMF programme of over $35bn.

The funding is, therefore, critical. But a question mark hangs over it because of the political repercussions of the hardships imposed on the country’s population of more than 220mn by the crisis and the remedial steps being taken and required but yet to be taken. To comply with the terms of a $6bn loan agreed with the IMF in 2019, Sharif’s government has withdrawn fuel and energy subsidies, which has sent prices, already high, higher still, aggravating public anger.

There are concerns about possible political backlash, as reflected in a rebound in Khan’s approval levels for the next elections, thus raising questions over whether the policy actions required to keep the IMF programme alive will be possible or be sacrificed over electoral considerations. The steps are needed not just for access to bailouts and temporary relief, but also for medium- to long-term economic stability and revival, and poverty reduction.

While Pakistan’s economy is on the brink, it has had to back down on its stance on trade with India. As Islamabad struggles to ease shortages and cool off prices of essential items, it has allowed imports from India.

Official data from the commerce ministry reported by the Business Standard shows that imports from India have shot up since the new government came to office in April, despite the restrictive bilateral trade policies of both sides.

India’s exports to Pakistan more than doubled to $142 million in the two-month period of April and May. It was $70 million during the same period a year ago.

A key import is sugar. India exported sugar worth $86 million during the two months. The exports also include pharmaceutical products, mineral fuels, coffee, tea, fruits and vegetables, plastics, iron and steel and matchboxes.

Earlier, India had withdrawn the most-favoured-nation (MFN) status for Pakistan in February 2019. New Delhi also raised tariffs on all imports from Pakistan to 200 per cent in wake of the Pulwama terror attack. The bilateral trade between the two neighbours dropped as a result from $2.6 billion in FY19 to $831 million, $329 million, and $516 million in FY20, FY21, and FY22, respectively. India’s imports from Pakistan were negligible.

The Imran Khan government had suspended all trade with India after the special status of Jammu and Kashmir was revoked. However, Pakistan opened up to import of drugs and pharmaceuticals from India in May 2020, soon after the coronavirus pandemic outbreak.

In March 2021, a committee chaired by the then finance minister of Pakistan, desperate to dampen the high domestic prices, allowed the import of sugar and cotton from India. But the decision was reversed by the Cabinet in less than 24 hours following political backlash.

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