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Pakistan's problems in the shadow of a trade war

10 Oct 2018 17:08|Marcin Lipka

"Deteriorating foreign exchange reserves, high trade and budget deficits, a currency that is weakening before your eyes and the 13th request for financial assistance from the IMF. All these elements are serious threats to Pakistan's stability, but what impact can they have on the global economy?" asks Marcin Lipka, Conotoxia Senior Analyst.

Pakistan does not often attract the attention of the markets. Over the years the economy has been so small that it has remained far from the interest of funds investing even in risky emerging markets. However, this situation has somewhat changed. From 2013 onwards Pakistan participates in the Chinese Economic Corridor (CPEC) project, which is part of Beijing's long-term "Belt and Route" strategy.

Huge investments

The broad cooperation between China and Pakistan, which began in 2013, assumes huge infrastructural investments for the country. Over a decade they are expected to amount to about 60 billion USD. They include the construction of a modern road network, the expansion of the railway network, an increase in the capacity of Pakistan's ports and energy investments amounting to half of the total amount.

Most of the projects are implemented with very attractive, sometimes even interest-free financing, which is provided by Chinese banks. Some projects are even built directly from the capital of the Middle Kingdom in exchange for a later share in revenues.

Therefore, conditions for Islamabad look very attractive, especially as such large investments can increase Pakistan's competitiveness and improve the country's productivity. Unfortunately, despite favourable investment conditions, they have clearly exceeded the country's potential.

Total crisis

Despite the serious financial participation of the Chinese, Pakistan must also provide part of the investment funds. In addition, the infrastructure boom is causing a strong increase in imports. Moreover, the improving economic situation has increased the citizen consumption.

As a result, the current account, which was relatively balanced between 2010 and 2015, now has a serious deficit exceeding 6% of GDP (according to IMF data for 2017). The fund estimates that the budget deficit will reach 6.5% of GDP this year. Meanwhile, two years ago it was 4.42%. Islamabad's currency reserves are also rapidly shrinking. Currently, they amount to about 11 billion USD, i.e. almost half of that in 2016. Market tensions have forced the central bank to devalue the local rupee. Pakistan's currency lost less than 30% in value against the dollar in a year.

The risks associated with the loss of liquidity in foreign currency led the authorities in Pakistan to apply for assistance from the IMF. Interestingly, this is already the 13th aid from the Fund to Pakistan in the last 30 years. However, only one US-run program has been fully implemented. It ended in 2016, which is precisely when the external imbalances and the investment boom were building up.

Global repercussions

Apart from Pakistan's issues, it is also worth noting the wider impact of recent events. In July, Mike Pompeo, US Secretary of State, had already warned that he would look at whether the government in Pakistan would use the IMF to "pay off unclear loans from China".

The US share in the IMF budget is about 17% and is the highest of all the Fund's contributors. Additionally, according to the Congress Bureau of the Budget (CBO), the maximum liabilities of the USA towards the IMF may amount to as much as 164 billion USD. As a result, the United States, by financing a significant part of its aid to Pakistan, allows Islamabad to repay loans to China and therefore contribute to Beijing's influence in the region through the "Belt and Route" initiative.

From Washington's perspective, this is difficult to accept, especially in the context of the increasing number of conflicts with the Middle Kingdom, of which, of course, the most important in the context of economy is the customs war. As a result, Pakistan's problems may further exacerbate rhetoric between the powers and contribute to prolonging fears about the condition of world trade.

10 Oct 2018 17:08|Marcin Lipka

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