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Home Investing News

Sri Lanka has defaulted. Will Pakistan be next? Lessons for the Philippines.

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August 7, 2022
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Sri Lanka has defaulted. Will Pakistan be next? Lessons for the Philippines.
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PHILIPPINE STAR/ EDD GUMBAN

Last April, the Sri Lankan government announced that it was defaulting on its debts, making it the first sovereign nation to default since the pandemic started. The island republic has depleted its cash reserves. The Sri Lankan people face a shortage of food, fuel, medicines, and electric power. At least 500,000 Sri Lankans have fallen into severe poverty in the last year alone. All these have led to civil unrest and the resignation and subsequent retreat of President Gotabaya Rajapaksa to the Maldives.

Pakistan is showing all the signs of going Sri Lanka’s way. With debts amounting to well over $125 billion (71.3% of GDP), the south Asian nation has only $7 billion in cash reserves. Pakistan is facing a cash crunch. It tried to borrow from China and Saudi Arabia to pay for the importation of its basic essentials, but both turned cold, spooked by the risk.

Pakistan had no choice but to turn to the IMF for a $6 billion bailout. The lifeline will likely come, albeit with stiff conditions. Pakistan will have to remove all fuel subsidies to save cash. This will severely impact the Pakistani people who are already suffering under the weight of 21.3% inflation.

Making matters worse is the rapid devaluation of the Pakistani Rupee which fell by 34% in the last year. The devaluation has made imports more expensive — a difficult situation since Pakistan is dependent on imports for its food, medicines, and other essentials. As it stands, food prices have become unreachable for most Pakistanis. Medicines are becoming scarce. The country suffers from frequent power outages to save fuel. Public anger is rising and people are taking to the streets.

Calls for the resignation of Pakistan’s Prime Minister, Shehbaz Sharif, are getting stronger by the day. But Sharif blames his predecessor for his country’s woes.

How did Pakistan get to this point?

Pakistan’s downfall has been in the making for 70 years. It has undergone one economic crisis after another since separating from India in 1947. In the last 30 years alone, the IMF has had to bail it out 13 times.

At the heart of Pakistan’s problems is political instability and the lack of continuity. Ousting incumbent Prime Ministers is a standards affair such that none of Pakistan’s past 22 Prime Ministers have finished their term.

Typically, the sitting Prime Minister would spend the first years of his/her term undoing the policies of the predecessor, only to be ousted before real reforms can be instituted. Case in point, in 1978 Muhammad Zia-ul-Haq banned labor unions and censored media. When Benazir Bhutto came to power, she spent the better part of her term legalizing unions and restoring freedom of the press. Immediately after, she was ousted by Nawaz Sharif. This has been Pakistan’s pattern for decades.

This pattern led to a chain of consequences that have proven disastrous. Necessary reforms do not gain traction; Prime Ministers become more concerned with staving-off power grabs than instituting real reforms; reforms, whenever instituted, tend to be populist; political instability leads to policy instability; foreign investors stay away; lack of investments leads to a sluggish manufacturing sector and import dependence; low productivity leads to low national revenues which forces the country to depend on loans to sustain itself.

Exacerbating matters is Pakistan’s “war brokering” business. Pakistan has been a breeding ground for militant groups who can be hired for a price. For instance, the Mujahideen fighters were contracted by the United States to resist Russian forces in Afghanistan in 1979. The Pakistani government also accepted some $1.2 billion a year for the US to use its roads, ports, railways, and airspace as it battled the Russians in Kabul. War brokering and militant group outsourcing has been mainstay in Pakistan’s economy even today.

Involvement in wars (even if not their own) contributed to Pakistan’s image as an unsafe and turbulent economy. Investors and tourists stay away, depriving the country of precious dollar revenues.

While the country languishes in dire straits, in comes China offering generous loans for the development of infrastructure. It proposed the development of the Gwadar Port which is strategically located in the Arabian Sea.

China used its debt trap strategy to gain control of the Gwadar Port. How does it work? First, China lures weak nations into acquiring massive loans for the development of infrastructure. Second, China imposes stiff terms designed to cause the borrower to default. Interest rates could reach 4% per annum as compared to 1% from development lenders such as the ADB. Chinese debt duration usually spans 10 to 15 years whereas it is typically 30-years with others. All construction suppliers, labor, and engineers are sourced from China, causing the funds to flow back to the mainland, not the host country. Third, when the country defaults, China takes over the asset and treats it like its sovereign property, using it for sole purpose.

Pakistan owes China some $24.7 billion. And since it defaulted on its debt obligations, China now occupies and controls the strategic Gwadar Port.

So, what are the lessons for the Philippines?

1. We must never allow ourselves to be import dependent since it makes us vulnerable. Self-sufficiency in food and basic essentials is a must for national survival. This means we must work towards a manufacturing and agricultural resurgence as soon as possible.

2. We should maintain strong financial fundamentals which include manageable debt levels, strong forex reserve positions, and manageable current account balances. The government must avoid populist policies like giving out subsidies, especially in a time when belt tightening is needed.

3. No matter how strong political rivalries may be, our laws and policies should always serve the national interest, not political agendas.

4. Continuity in policies across administrations is critical.

5. Steer clear from Chinese debt traps.

Pakistan’s situation is lamentable and our hearts go out to the Pakistani people for their sufferings. May this crisis serve as an impetus for political and financial reforms which are vital for Pakistan’s recovery.

Andrew J. Masigan is an economist

andrew_rs6@yahoo.com

Facebook@AndrewJ. Masigan

Twitter @aj_masigan

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