Economists ascribe Sri Lanka’s recent financial problems to a severe decline in tourism and remittances, as well as a substantial tax cut, but poor governance is atop the list of the factors that played havoc with the island nation’s economy, which relied heavily on tourism and remittances. Both these sources were hit badly by the Covid pandemic as the workers were laid off on a mass scale.

Pakistan’s land area, population and GDP are 12 times, 10 times and four times higher than Sri Lanka’s, respectively. However, Pakistan’s per capita GDP is half of the island nation. Despite these differences, a significant decline in Pakistan’s foreign exchange reserves and a persistent political crisis have given the international community the impression that the country is following in Sri Lanka’s footsteps.

Sri Lanka was the first South Asian nation to liberalise its economy through open economy reforms in the late 1970s. However, it is currently a state in crisis after defaulting on a $78 million payment in debt interest in May 2022 for the first time in its history.

Its central bank said that the county’s tourism and remittances decreased by 86 per cent and 18pc, respectively, in 2021 as compared to 2019, as the nation is facing a scarcity of fuel and medicines for want of dollars for imports. The country has a reserve of $1.5 billion from China under swap agreements, which cannot be used for imports. Thus, the economy was paralysed.

Similar to Sri Lanka, Pakistan’s roots of economic deterioration are many decades in the making

Two political parties have been dominating Sri Lanka’s political system. In their race to power corridors, they employed populist tactics — such as tax cuts and other subsidies — to attract voters at the cost of the country’s overall economic efficiency. With an average 6pc growth from 2007 to 2016, the country was classified as an upper-middle-income nation by the Asia Development Bank.

Did Sri Lanka move to default suddenly?

Most critics have concentrated only on its past two-year performance. However, the country’s inability to diversify its manufacturing base was the structural root cause of the economic collapse, which began three decades ago.

Colombo borrowed from international sources to rebuild infrastructure rather than invest in production-related industries. Consequently, exports’ production base and growth shrank, and foreign earnings became dependent on remittances and tourism.

The balance of payment issue was evident in 2016, before the recent terrible financial crisis. A $1.5bn bailout package was negotiated with the International Monetary Fund (IMF). But the weak government soon offered a substantial tax cut to overcome an ongoing political crisis and the Covid pandemic.

The government banned the import of fertilisers to correct the balance of trade, but it dealt a blow to the agrarian economy leading to a sharp decline in crop production and a massive increase in food prices. Thus, the burden of foreign debt increased. In November 2021, the ban was subsequently lifted.

Currently, Pakistan’s economy has far exceeded its threshold level of public debt and is unable to pay it. As per an IMF report, the country needs a $7bn loan to tackle this crisis and in the three years leading up to 2026, Pakistan must repay a total of $75bn, or $25bn per year.

There are signs of temporary relief. Recently, $10bn in pledges were made by Pakistan’s donors at the Geneva Climate Conference, but 90pc of those pledges are in the form of project loans, offering no immediate support for the balance of payments crisis.

Owing to a $3bn lifeline provided by the United Arab Emirates in the form of a rollover of $2bn of existing debt and additional funding of $1bn, Pakistan has managed to escape default temporarily. In addition, the Saudi Fund for Development agreed to finance $1bn in oil imports on deferred payment.

As in Sri Lanka, is the economic detrioration occurring rapidly? In terms of the roots of the financial crisis, Sri Lanka and Pakistan share many similarities.

Pakistan’s economy took a turn in the 1980s when it indulged in public debt due to its budget deficit. The country is also engaged in a war on terrorism for the last many decades, like the civil war in Sri Lanka. The funds received for the fight against terrorism held the balance of payments steady.

When the pandemic hit the world economy, it impacted Pakistan’s leverage of domestic production due to the lockdowns. Moreover, the Ukraine-Russia war resulted in higher oil prices escalating the cost of production for Pakistan, which heavily relies on foreign input supplies. Power tariffs increased manifold because of higher production costs causing industries to shut down their operations.

Since the Russian invasion of Afghanistan in 1979, the country has experienced significant changes to its political and economic structure. The world powers provided substantial financial, military, and political support to Pakistan and related militant organisations to recruit youth to fight against the Russian forces.

After the Russian pullout from Afghanistan, the international community withdrew its support. The militias, now well-resourced in terms of money, weapons, and religiopolitical influence in the region commenced infighting as terrorism rapidly spread throughout Pakistani society.

In the meantime, political instability, corruption, social injustice, and economic disparity fueled the emergence of various manifestations of terrorism. After 9/11, Pakistan again became the frontline state in the global war against terrorism. Pakistan effectively played its role in combating terrorism and militant groups, which increased terrorism within the country.

From the past, we may deduce that Pakistan is a project economy. Whenever the international community grants Pakistan a project, the balance of payments problem is overcome. In the absence of a new project, the financial crisis is worsening, raising the question: Is Pakistan following Sri Lanka’s footsteps?

Historical similarities between Pakistan and Sri Lanka include a heavy reliance on remittances, fewer exports with low added value, a diminished manufacturing base, political instability, popular political tactics, a colonial institutional framework and natural disaster.

However, Pakistan has always maintained cordial relations with certain nations, which have been helping it out of the financial crises. It is to be seen if these nations again come to its rescue, disregarding the underlying causes of financial problems.

The writer is deputy chairman of the board of governors of Minhaj University, Lahore

Published in Dawn, The Business and Finance Weekly, February 13th, 2023