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Pakistan just secured a lifeline from the International Monetary Fund.  Here’s what it needs to do next.

On June 30, Pakistan received a nine-month $3 billion bailout loan through a Stand-by Arrangement with the International Monetary Fund, bringing relief to many. This deal, which still requires approval from the IMF board in July, was reached just hours before the expiration of the previous agreement with the IMF on the same day. It was expected that Pakistan would not fulfill the $7 billion loan agreement that also expired on June 30. This marked the 23rd IMF loan agreement that Pakistan had failed to complete, setting a record in the institution’s history.

The loan is widely viewed as a lifeline for Pakistan, as the country is currently facing one of its most severe economic and political crises. While it is a temporary measure, the loan provides much-needed respite, as Pakistan is grappling with a severe balance of payments crisis and dwindling foreign exchange reserves.

The program aims to provide the necessary foreign exchange to resume imports, assist listed companies in gradually reviving their partially closed production, and stimulate economic activities in the country.

As Pakistan secured the much-needed funds from the IMF, signs of economic recovery began to emerge. This new program has also encouraged other donor agencies and countries to extend additional financing to Islamabad. In fact, they had pledged $9 billion at a meeting in Geneva back in January.

These inflows will bolster foreign exchange reserves and enable the cash-strapped country to prepare for reopening imports. With the IMF program revitalized, the risk of default on the critically low foreign exchange reserves, which stood at $3.5 billion, has receded in the short to medium term. Unsurprisingly, the stock market responded positively to this news, experiencing a significant increase of 2,231 points or 5.38%.

For several months, the market had been stagnant, ranging between 40,000 and 42,000 points due to the partial closure of the economy. However, it remains to be seen whether the market will sustain these historic single-day gains, especially given the current record-high key policy rate of 22% set by the central bank.

According to Bloomberg, the KSE-100 index had become the world’s cheapest equity benchmark, as concerns over political turmoil and the risk of default led investors to flee. The agreement helped the wounded Pakistani rupee which gained value against the dollar, rising by Rs5, and reaching Rs285 in the open market.

So far, Pakistan has managed to avoid a default situation, which is a short-term relief. Business and public sentiment have improved as a result.

However, the long-term reform agenda of the government remains a significant concern. Several questions need to be addressed. Will the country be able to free itself from the constraints imposed by the IMF after the current Stand-by Arrangement expires? Can it implement the necessary structural reforms urgently required to stabilize its fragile economy? Will Pakistan establish a strong civilian government capable of executing these long-term measures? Can the hybrid political system effectively address economic challenges? Will elections take place as scheduled?

The current government is set to be ousted from power later this summer, and elections must be held within three months by the newly appointed caretaker government, which has yet to be announced. In any case, according to the constitution, general elections must occur before November 12, with late October being the anticipated timeframe. The key question is whether free and fair elections, as mandated by law, will take place.

Regrettably, the evidence suggests that there will not be a significant improvement in Pakistan’s governance score. General elections are widely anticipated to be rigged, and the country is likely to continue muddling through. Given the growing influence of the military in Pakistan’s political, economic, and security spheres, future civilian governments will face challenges in implementing the necessary reforms.

What must be done immediately is to stabilize the country’s politics to ensure economic stability. Political uncertainty is wreaking havoc on Pakistan’s economy, and contrary to some analysts’ arguments, the economy is not causing political instability. Political stability can only be achieved when the military ceases its blatant interference, which is unlikely to happen anytime soon.

Meanwhile, the government must undertake the reform measures demanded by the IMF. Firstly, the country must swiftly escape the debt trap and ensure meaningful servicing of its foreign debts, including those owed to the IMF. A comprehensive plan needs to be formulated to achieve this goal. Pakistan currently faces an enormous external debt servicing requirement of approximately $23 billion during the 2023-24 fiscal year, which is nearly six times greater than the central bank’s $4 billion forex reserves.

Pakistan’s finance minister, Ishaq Dar, revealed that when the PTI government left power, the country’s total foreign loan and liabilities had reached $130 billion, compared to $70 billion in 2017. He stated that a future roadmap had been devised for economic revival, with special initiatives being taken in agriculture, IT, mining, and other sectors. Dar expressed gratitude for China’s substantial assistance, which played a vital role in boosting Pakistan’s overall reserves to $10 billion. He added that the government’s target is to further increase reserves by $15 billion by the end of its term.

As of March 31, the IMF had issued loans totaling $155 billion to support weak economies, and Pakistan ranked fifth on the list of countries with the highest borrowing from the IMF. However, with the additional $3 billion loan through the Stand-by Arrangement over the next nine months, Pakistan will move up to fourth place in this list. Argentina ranked first with $46 billion in IMF loans, followed by Egypt with $18 billion, Ukraine with $12.2 billion, and Ecuador with $8.2 billion. Pakistan, with loans amounting to $10.4 billion, will surpass Ecuador and become the world’s fourth-largest IMF borrower. It is also currently the largest IMF borrower in the region.

The government must prioritize fulfilling the IMF’s conditions without delay. Although the government has already met most of the IMF’s prerequisites, these efforts are still considered insufficient. The new loan agreement from the IMF comes with several conditions, including the removal of remaining import restrictions, further reduction in energy subsidies, and a stronger commitment to a market-determined exchange rate. Additionally, the IMF is requesting a ban on unbudgeted spending, prevention of new tax exemptions, and streamlining of state-owned enterprises.

It is crucial to develop a comprehensive plan to modernize Pakistan’s entire decision-making apparatus within the government, as the current system is inefficient and ineffective. The state bureaucracy needs to be reformed, red tape should be reduced, and duplicative functions and uncoordinated decision-making at various levels of government should be curtailed. One positive step was the establishment of the Special Investment Facilitation Council (SIFC) on June 17, led by the prime minister and including the army chief as a member. However, it is noteworthy that the military will manage the SIFC.

The council’s primary objective is to serve as a comprehensive “single window” to streamline bureaucratic procedures. Within a short period, the government agreed to lease four berths of Karachi Port Trust to Abu Dhabi Ports for 25 years, a transaction completed quickly without competitive bidding or involvement of an independent consultant for price discovery, deviating from past practices. The Sharif government has shown great enthusiasm for this initiative, claiming that concrete investment plans totaling $20 billion have already been formulated, with the potential for this figure to exceed $100 billion. However, many independent analysts doubt the feasibility of these plans in the near future.

Pakistan must address its high inflation, which remains a pressing issue. Inflation is causing significant dissatisfaction among the public and has become a major concern. In June, inflation slowed to 29.4% on a year-on-year basis, compared to a 38% increase in the previous month and a 21.3% increase in June 2022, according to the Pakistan Bureau of Statistics. On a month-on-month basis, inflation decreased to 0.3% in June, compared to a 1.6% increase in the previous month and a 6.3% increase in June 2022.

Pakistan must formalize its economy and enhance tax collection. The country’s informal “black economy,” which goes untaxed and undocumented, is significant and estimated to be as large as half of the formal economy. India has successfully tackled this problem, and Pakistan can follow suit. Pakistan must expand its tax base immediately and ensure taxation of all sources of income. The country is living beyond its means, and this must be halted promptly. Wasteful expenditure should be curbed as well. While these common-sense requirements have widespread agreement, meaningful progress remains elusive. Currently, only 1% of Pakistanis file their income tax returns.

The government needs to address its bloated structure and reduce wasteful expenditures, particularly the colossal defense budget. Despite promises by the government to cut government expenses, substantial reforms are unlikely to materialize. Prominent businessman Mian Muhammad Mansha accurately pointed out that the federal government lacks funds and collects money solely to pay government employees’ salaries. He also emphasized the need to lower interest rates, which requires the privatization of state-owned entities. Mansha highlighted overstaffing in government departments as a major issue affecting Pakistan’s economy.

Pakistan should prioritize the privatization of numerous inefficient state-owned enterprises, regardless of their size. Regarding the power distribution companies (DISCOS), the Sharif government’s plan to hand them over to the provinces is misguided. Mansha rightly noted that DISCOS suffer significant losses due to non-recovery, with distribution companies in Hyderabad, Sukkur, Quetta, and Khyber Pakhtunkhwa recovering only 24% of their expenditures. There is ample room for improvement in this regard, a point agreed upon by all.

Finally, Pakistan must address two significant issues that are hindering progress. The current hybrid political system is ineffective and needs to be reevaluated. Citizens may be hesitant to criticize it now, and the leadership crisis at all levels of government poses significant challenges that are difficult to resolve. Achieving meaningful reform requires capable governance at all levels, yet many of the country’s best minds have already left. Other bright minds are also leaving Pakistan. Given these circumstances, expected reforms are unlikely to materialize in the near future. Nonetheless, muddling through is preferable to a collapse.

Sohail Mahmood is an independent political analyst focused on global politics, U.S. foreign policy, governance, and the politics of South and West Asia.