This is the ninth edition of The Polycrisis newsletter, written by Kate Mackenzie and Tim Sahay. Subscribe here to get it in your inbox.
In the torrent of criticism of the IMF and World Bank for their role in deepening Pakistan’s economic troubles (there is plenty of blame owed to them) the role of Pakistan’s own ruling class often gets pushed to the background. What you may not have heard about Pakistan—notorious for having received 23 IMF bailouts, for being a nuclear-armed state with terrorist groups, for suffering climate catastrophe of biblical proportions—is that the nation of 220 million people is being screwed by its domestic elites.
IMF Managing Director Kristalina Georgieva got it right this past weekend at the Munich Security Conference when she argued for reforming domestic tax collection. “It shouldn’t be that the wealthy benefit from subsidies. It should be the poor,” Georgieva told a German broadcaster.
The recent floods which devastated one-third of the country are an emergency of unprecedented scale, and Pakistani diplomats have been shrewd in using the crisis to press for an urgently needed global “Loss and Damage” fund. What the floods must not become is more cover for the country’s ruling elites to defer domestic reform.
Earlier this month, Prime Minister Shehbaz Sharif complained that the IMF was giving his country a “tough time” over accessing funding, in the midst of an “unimaginable” economic crisis. Former PM Imran Khan, recovering from a failed assassination attempt, is preparing for a dramatic election season ripe with IMF-bashing. But domestically, none of these warring factions has proposed reforming the regressive tax code, which is riddled with exemptions for powerful military generals, judges, and landowners.
During periods of crisis, the parliament frequently resorts to raising sales and fuel taxes, and levies on less politically powerful sectors, increasing cost-of-living burdens on consumers and rural peasants while driving more ordinary economic activity into the sprawling black market.
On February 14th, the federal tax board raised the goods and services tax from 17 to 18 percent, following recent increases to petroleum tax, in a move that would deepen Pakistan’s existing revenue woes. Pakistan’s federal income tax ordinance “contains 118 pages of exemptions and low rates of taxes granted to the rich and powerful,” writes Huzaima Bukhari, an attorney and tax expert, while “those who can hardly afford to eke out a decent human living are expected to contribute to the treasury.”
For the coming year, Pakistan’s government estimates tax revenue of PKR 5 trillion. With interest rates rising another 300 basis points, the new estimate of debt servicing costs has soared to PKR 5.2 trillion. In other words, Pakistan’s entire annual revenue can no longer service payments on its debt. Meanwhile, central bank reserves have dipped precipitously in the last year. At present they are not enough to cover the cost of three weeks of imports, further hammering industrial supply chains and consumers.
Researchers at the World Resources Institute tallied the carnage of last August: “Torrential rains and flooding impacted 33 million people and caused more than $40 billion in economic damages. The catastrophic flooding left 1,700 people dead, 2 million homes destroyed and killed over 900,000 livestock… The country is now experiencing mass displacement, food insecurity, loss of livelihoods and an increased risk of waterborne disease, drowning and malnutrition.”
Under these strained conditions, Pakistan’s legislature is now negotiating a $6.5 billion bailout package with the IMF. The nation has gone to the IMF more than any other country, including Argentina. But this time—in the wake of the floods, and recent terrorist attack in Peshawar reviving geopolitical fears of Pakistan as a “too nuclear to fail” state—the crisis has a new urgency.
Given dismal tax revenues, how is Pakistan’s economy functioning?
The EU’s geo-economic decision to include Pakistan in its free-trade zone has helped. It is Europe, and not China, that is the largest importer of Pakistani export goods. And sales, dominated by textiles, have soared since 2014, when the EU lowered import duties to zero. But that GSP status is up for renewal in 2023, conditional on labor, environmental, and good governance standards.
Meanwhile, the ongoing oil boom in the Gulf means 9 percent of Pakistan’s GDP comes in the form of remittances from millions of its citizens working there. Dollar infusions from Saudi Arabia are also a crucial lifeline. The Kingdom has stepped in with multi-billion dollar credit lines, sent dollars-for-military-aid, and requested nuclear know-how as they seek to deter Iran.
But these are temporary measures—as were, after all, each of the IMF’s successive rescue packages.
In a 2012 LSE paper, former IMF economists Ehtisham Ahmed and Azeali Mohammed explain Pakistan’s twinned domestic inertia and inconsistent relationship with official external financing. They see the “stop-go” of official debt, particularly from the US, as delaying the day when Pakistani rulers would be held accountable for building domestic state capacity.
“Exceptionally favorable conditionality and flexibility in giving waivers, on not meeting even soft conditionality standards, has led successive Pakistani governments to treat lightly the fundamental issue of domestic resource mobilization,” they write. This extended the rule of “weak civilian governments vying for popularity, and military governments without political support seeking legitimacy.”
Already by the 1980s, Pakistan had broken the “golden rule” of fiscal prudence, and began borrowing to fund current spending. Nearly every subsequent government deferred the need to expand the tax base and close loopholes.
Pakistan made and abandoned attempts at reforms to raise tax revenue throughout this period, including in the mid-1980s, the late 1990s and mid-2000s. Each effort foundered when geopolitical events led to a surge in US support and cheap dollars. The IMF’s own Independent Evaluation Office in 2002 pointed out that the country was almost continuously in Fund programs between 1988 and 2000, with all but one of the seven programs derailed by “substantial policy slippages”. Despite IMF efforts, tax revenue actually fell in that period to 12.1 percent of GDP, from 13.5 percent.
Ultimately, Pakistani elites’ resistance to broadening the country’s tax base point to the primacy of geoeconomics in determining the country’s fortunes. To the US, Pakistan is above all a military outpost—which can always be propped up with accommodative lending. That has pushed the IMF to play a role that IMF economists themselves say is toxic for the country’s ambitions to be a modern, tax-collecting state.
What revenue Pakistan does collect is not always effectively channeled into urgent investment. (See former Deputy Governor of the State Bank of Pakistan Murtaza Syed’s thread on the dynamics: 5–8 percent fiscal deficits in the public sector; low savings in the private sector.)
Power and power
The country’s energy infrastructure illustrates this. Ahmed and Mohammed wrote in 2012 that under-investment in energy had led to planned power cuts which particularly affected the industrial and export sectors. Today the country’s power generation capacity well exceeds the demand on it, but a quarter of the population still has no electricity at all, mostly because the grid doesn’t reach rural areas.
Burned by Europeans outbidding them for LNG shipments last year, the country is now declaring it will increase coal-fired power generation four-fold, running on domestic fuel that doesn’t require precious hard currency. It was not “ immediately clear” how the coal plants would be financed, Reuters noted, when even China and Japan are backing away from such projects. Nor is it clear how building more of the centralized over-indebted coal power would improve an energy system already hampered by inadequate transmission infrastructure.
The World Bank, hardly a champion of climate action, said in 2020 that even Pakistan’s locally fuelled coal power was uneconomic due to falling costs of renewables like wind and solar, which only supply about 2 percent of Pakistan’s power. Tax breaks on solar and wind equipment were reversed early last year in a dash to unlock another tranche of IMF finance. Improving a country’s energy system requires the patient policymaking that neither the government of the day nor international financial institutions have brought.
The available solutions to the crises that Pakistan faces raise suspicions domestically and internationally: While the IMF worries that bailouts will pass through directly to Pakistan’s elites, the US worries that any debt haircuts it accepts will only furnish repayments to Pakistan’s Chinese creditors.
As finance ministers gather this week in India, the G20 leader is putting more pressure on China to take haircuts on distressed debt. But with China continuing to call for multilateral lenders to take losses in the restructuring—an unreasonable and perhaps deliberately obstinate request, as Brad Setser has argued—Pakistan’s nest of international lenders looks as intransigent as its brazenly elite-captured domestic economy.