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Another Sri Lanka?

Pakistan must rationalise its economic policies now if it wishes to avoid the situation as Sri Lanka.

By Syed Zain Abbas Rizvi | June 2022

The Sri Lankan politico-economic crisis is an apt modern-day case study of epic proportions. Economic mismanagement, familial political hierarchy, and clueless policymaking have dealt this daunting reality to the island nation. A cursory review of the situation suggests that this debacle was waiting to wreak havoc for years. However, a comprehensive analysis uncovers an intriguing pattern of mishaps that actually hastened Sri Lanka’s downfall. That pattern, somehow, carries an uncanny resemblance to the recent turn of events in Pakistan. Thus, the direction of Sri Lanka’s current misery could foreshadow the nightmare in store for Pakistan.

On the political front, both countries have followed an identical playbook - to the letter! The No-Confidence Motion against Imran Khan disillusioned his allied parties in a heartbeat. In mere weeks, Khan lost his hairline majority in the parliament. The subsequent fiasco eventually climaxed in Khan’s exit and a regime change. In a parallel setting, extreme public pressure and mass protests distanced the coalition partners from Gotabaya Rajapaksa’s ruling party. In early April, all 26 members of the Sri Lankan cabinet resigned en masse. Rajapaksa’s simple majority of 113 faltered in the parliament as more than 40 members of the ruling coalition rejected his proposal of a ‘national unity government’ under his leadership. Country-wide protests and a brutal state of emergency ultimately led to the unexpected - the resignation of prime minister Mahinda Rajapaksa from the office. Now, both nations are in political limbo - one led by an isolated president while the other ruled by a coalition of fraying parties. Making matters worse, economic desperation is weighing heavily on the backdrop of the ongoing political turnover.

The economics of the two nations - unlike the political drama - varies to a certain extent. Sri Lanka’s moves towards instability started in 2015. The Central Bank of Sri Lanka (CBSL) began engaging in a Keynesian fiscal stimulus program. Printing more money to close the output gap, the CBSL triggered an artificial forex shortage by using domestic savings through the national credit system. While the strategy helped push inflation and spark ephemeral growth, low-interest rates and massive devaluation of the Sri Lankan Rupee (SLR) ultimately dried up the forex reserves. Today, Sri Lanka’s dollar reserves amount to just $150 million - not enough to meet even a month worth of imports. Meanwhile, the SLR-USD parity has further deteriorated to 359. Debt servicing aside, the country is unable to import even food essentials, fuel, and medicines. That is a recipe for a humanitarian crisis waiting to unfold.

Pakistan has similarly witnessed a sharp decline in its dollar reserves in the current fiscal year. From a record high level of $20.15 billion in August 2021, the forex reserves held by the State Bank of Pakistan (SBP) have shrunk by almost 50% to $10.5 billion. The main culprit is the intermittent debt servicing costs without matching investments to offset the decline. However, unlike Sri Lanka’s interventionist soft-pegged exchange rate regime, Pakistan has rightly followed a clean float mechanism at the behest of the IMF conditions. While the Pakistani Rupee (PKR) has devalued by over 50% in the last five years, the currency is not artificially supported. In fact, the Pakistan Real Effective Exchange Rate (REER) - PKR exchange rate weighted against a basket of 37 currencies of major trading partners - is settled in the 95-100 range: a level that makes exports more competitive and discourages imports. Unfortunately, Pakistan’s imports are predominantly price inelastic, while quality exports are not nearly enough to cover the deficit. Hence, borrowing costs have consistently surged to finance the growing import bill - making Pakistan a highly indebted country in South Asia.

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