Is Pakistan’s economy out of the woods and has it finally stabilized under the tutelage of successive International Monetary Fund (IMF) programs? That was a question on at least a few minds at the recently concluded IMF-World Bank Spring Meetings in Washington.
Over the last few years, Pakistan has juggled political and economic strife, beset not only by instability in government but also soaring inflation and depleting foreign exchange reserves. External shocks, such as the Ukraine war and supply side pressures amid the COVID-19 recovery, exacerbated these problems by pushing up commodity and oil prices. These difficulties complicated negotiations with the IMF, with which Islamabad has been in a program since 2019. However, over the past year, Pakistan’s economic situation has improved, driven by favorable trends in global commodity prices, putting it on surer footing with the IMF.
But as stability was returning to Pakistan’s relations with the Washington-based lender of last resort, Pakistan and India got embroiled in yet another military conflict. These tensions spilled over into the diplomatic and economic spheres when the Indian government opposed Pakistan’s access to IMF funding.
For now, despite India’s efforts to scuttle Pakistan’s credit lines, the IMF has approved the disbursal of a tranche of USD $1 billion for Pakistan’s overall USD $7 billion program and confirmed a fresh USD $1.4 billion loan for climate resilience. Yet, Pakistan must be careful going forward, as international pressure on it may potentially increase following the India-Pakistan crisis. It should also not squander the economic progress made due to the military confrontation with India in the short to medium term. Instead, Pakistan must focus on its longer-term reform agenda to come out of the cycle of IMF programs.
Over the past year, Pakistan’s economic situation has improved, driven by favorable trends in global commodity prices, putting it on surer footing with the IMF.
Origins of Economic Strife
Pakistan’s ongoing economic crisis is traceable to the mismanagement and political drama around its previous IMF program, the 2019 Extended Fund Facility (EFF) loan that concluded in mid-2023. During that time, inflationary pressures due to a COVID-19 recovery and Ukraine War-driven global commodity price increase, slow growth, and mounting sovereign debt presented a major shock to the Pakistani economy. That shock in early 2022 damaged former Prime Minister Imran Khan’s political legitimacy who tried to correct it by imprudently initiating a fuel subsidy that burned through Pakistan’s limited foreign exchange. Over the next few months, the country descended into acute political turmoil as Khan was ousted from power. As a result, the combination of global factors, economic missteps and political upheaval generated the worst economic crisis of Pakistan’s history, at least since the economic sanctions of 1998.
The liquidity crisis deepened by December 2022 when official foreign exchange reserves plummeted to USD $5.8 billion. Inflation was at an all-time high, averaging around 30 percent year-on-year and foreign exchange was able to cover barely one month of a mounting import bill. An international bond payment of USD $1 billion in this backdrop added to pressure and domestic uncertainty. Given that many countries like Sri Lanka and Egypt had either defaulted or were on the verge of default against their own debt, many analysts believed that Pakistan too would default, but this situation was eventually avoided. Nonetheless, the fund crunch remained.
By early 2023, Pakistan’s relationship with the IMF was under considerable stress. Pakistan has long had testy ties with the IMF because Islamabad has stalled on structural reforms recommended by the lender. For example, under the 2019 EEF, the IMF had proposed eliminating preferential treatment and tax breaks for the agriculture and textile sectors, broadening the tax base, and improving tax compliance. Additionally, the IMF had encouraged reforms in the energy sector, including scrapping subsidies on fuel, gas and electricity, and implementing cost-reducing measures like improving distribution efficiencies and integrating captive power into the grid.
Pakistan’s 2019 EFF was also affected by the global liquidity crisis that followed the Russia-Ukraine war. One specific negative impact of that was that the Fund mission took longer to complete the ninth review of the EFF. The IMF turned out to be particularly unforgiving on the 20 or so conditionalities it negotiated with Pakistani authorities in these discussions, to a point that the program was derailed. After frantic political efforts, a new short term Stand By Arrangement was confirmed in July 2023 after the intervention of Prime Minister Shehbaz Sharif, which helped Pakistan avert an imminent default.
Changing Fortunes
In net-importing and oil-thirsty economies like Pakistan’s, macroeconomic stability is largely defined in terms of dollar reserves. Close to the end of Sharif’s tenure in August 2023, foreign exchange reserves stood at around USD $8 billion—their lowest among the previous few years. Dollar reserves were low at the time the caretaker government stepped into office close to the fourth quarter of 2023, but stabilized between USD $12 billion and USD $15 billion for the rest of the year until February 2024 when Pakistan went into elections.
When Sharif returned to power in Feb 2024, he picked Muhammad Aurangzeb, a banker by profession who had then been leading one of the larger private sector banks in Pakistan, to be his finance minister. Through his past global professional experience, Aurangzeb brought to the office an ability to effectively work with the IMF. He was aided by an improving global economic landscape, which made an otherwise wobbly fiscal situation look better. For example, from around early 2024, the prices of key global commodities began to decline due to the reestablishment of export routes in Ukraine, supply chains from other countries coming online, and a decrease in demand in some key economies due to economic slowdowns. Consequently, inflation was gradually tamed to its current level of 0.7 percent year-on-year, which is the lowest rate of the last six decades. The ease on the inflation front provided confidence to the Monetary Policy Committee (MPC) to lower the policy rate, which has been revised down to 12 percent from a high of 22 percent in June 2023.
The improving global landscape—and a stronger inclination toward reform in Islamabad— created an opening in July 2024 when Pakistan and the IMF reached a USD $7 billion Staff-Level Agreement (SLA) for a 37-month EFF. One of the many IMF conditionalities for this program is a gross financing requirement of USD $5 billion, which Pakistan must raise from non-IMF partners. Of this requirement, USD $2 billion was needed as a firm commitment for FY2025 while the rest had to be raised as a soft commitment for the remaining duration of the program. Islamabad has sought to fulfill this requirement through a mix of sources, including commercial loans from Gulf Cooperation Council (GCC)-based financial institutions and a USD $1.2 billion deferred oil facility from Saudi Arabia.
[…] The government may be tempted into extravagant development spending and further lowering the interest rate. These two measures will have the effect of putting Pakistan on an expansionary growth path that it can’t finance with limited foreign exchange and also on the wrong side of the IMF, which has insisted on avoiding the urge to chase short-term growth spurts.
Path Forward
With Pakistan and the IMF reaching agreement on the first review of the EEF in March and Islamabad slated to receive a fresh USD $1.4 billion loan for climate resilience, Aurangzeb arrived in Washington recently with a stronger case to present at the 2025 Spring Meetings with the IMF.
While the IMF continues to insist upon the agreed taxation reforms and gross financing arrangements, Aurangzeb now presides over a relatively stable economy. While foreign exchange reserves have remained static, remittances have risen significantly and the increase in exports has recently begun to outnumber the rise in imports, giving a positive outlook to the external account and balance of trade.
However, the danger in the macroeconomic dynamics that are now developing is that the government may be tempted into extravagant development spending and further lowering the interest rate. These two measures will have the effect of putting Pakistan on an expansionary growth path that it can’t finance with limited foreign exchange and also on the wrong side of the IMF, which has insisted on avoiding the urge to chase short-term growth spurts. Additionally, while the Indian abstention was not successful in derailing the first review of Pakistan’s ongoing IMF program, any future escalations with India might exert pressure on Pakistan’s civil budget by expropriating resources away from non-military uses, and distract the reform agenda by disturbing the optimal utilization arrangement finalized with the IMF.
Aurangzeb has done well so far to build a good rapport with the IMF by maintaining a positive trajectory on headline macroeconomic numbers. Pakistan must now resist the temptation to squander that progress.
Views expressed are the author’s own and do not necessarily reflect the positions of South Asian Voices, the Stimson Center, or our supporters.
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Image 1: Prime Minister’s Office, Government of Pakistan via X
Image 2: International Monetary Fund via Flickr
