Pakistan Faces Economic Devastation if Iran War Prolongs, Report Warns

"The country's misfortune is compounded by timing. This is not an economy facing a shock from a position of comfort. It is one bruised by four years of painful stabilisation, marked by a historic cost-of-living crisis and an unprecedented decline in income that has wiped out the gains of the last decade. In virtually all its previous crises, Pakistan has been tipped over the edge by rising commodity prices. But this usually happens after a period of domestic overheating," former acting governor of State Bank of Pakistan (SBP), Murtaza Syed, wrote in The News International.

Pakistan vulnerability is further increased since it virtually has no room to respond to an external shock. With less than three months of import cover, Pakistan's foreign exchange reserves remain thinner than in almost any other country. Pakistan's public debt burden is difficult to manage as the government's debt is worth 70 per cent of Gross Domestic Product (GDP) and gross financing needs being among the highest in the world, leaving little room for countercyclical action.

Higher oil, gas and fertilizer prices will increase transport and food costs, causing a recession. A prolonged slowdown in West Asia will impact remittances and external financing and an unsettled regional environment will cause extreme pressure on Pakistani currency leading to inflation.

"Some will hope that the current IMF programme will cushion the blow. But this is false comfort. Although necessary to prevent default, the Fund programme will not by itself solve the problem. The size of the programme cannot be materially increased because Pakistan's repeated past borrowing has nearly exhausted limits under the Fund's access rules. And in the absence of stronger buffers, the last Staff Report has already telegraphed that the programme will remain contractionary in the face of a commodity price surge," wrote Murtaza Syed.

In the current situation, fiscal tightening, higher interest rates and depreciation of exchange rate will be unavoidable. However, they will also increase the slowdown at the very moment when Pakistan's economy needs breathing space. This policy mix will be unable to protect the most vulnerable from stagflationary shock. The standard IMF playbook for demand compression will be a dangerous gamble that could cause unrest and affect the already battered social fabric.

"A better and safer response can be engineered. But it will require swift action and unabashed candour about the limits of the current policy framework. If the war drags on, Pakistan should not rely on austerity alone. A more optimal policy mix would involve targetted fiscal and monetary stimulus for vulnerable households and firms, together with some foreign exchange intervention and temporary import restrictions to reduce disorderly volatility in the rupee and a surge in inflation," wrote Murtaza Syed.

- IANS