If you were a schoolteacher, how would you grade Pakistan’s economy? According to leading international credit agencies such as Moody’s and S&P Global (formerly known as Standard & Poor’s), the answer is a C-level grade.

In the international market, Pakistan’s credit rating (Moody’s: Caa2; S&P: CCC+) is referred to as “junk” status, ie lending to the country comes with a high risk of non-repayment and default. Forget earning a distinction, we’re just a few points away from dropping out of school entirely.

Why does this matter? Well, because all sovereign nations rely on borrowing money — that’s how they finance productive investments in areas such as health, education and infrastructure, betting that the future returns they generate will far outweigh the cost of interest on their initial loan.

Unfortunately for Pakistan, its junk rating means that most lenders are not willing to extend the country any credit, or will only do so at prohibitively high interest rates, effectively stunting our population’s development.

A weak tax base, a trade imbalance and mounting debt have pushed Pakistan’s economy into junk status. Can the country emerge from this economic spiral?

There are two central reasons behind Pakistan’s junk credit rating: we don’t collect enough rupees (ie tax revenue) and we don’t earn enough dollars (via exports).

THE TAX COLLECTION CONUNDRUM

Quite simply, our tax authority does not collect enough money. Pakistan’s tax-to-GDP ratio is one of the lowest in the developing world. Since inflation was rebased in 2015-16, the country’s annual inflation rate has averaged 12.9 percent, while revenue growth in nominal terms has clocked in at 12.3 percent. In fact, the Federal Board of Revenue’s (FBR) collection in real terms (ie adjusted to inflation) has actually declined in four of the last eight years.

A major consequence of FBR’s failure is that the government is forced to borrow money simply to meet its day-to-day expenditures. Since the government doesn’t earn sufficient tax revenue, those debts are then repaid by borrowing yet more money.

Thus, a negative spiral emerges, whereby the government is forced to borrow at ever-higher interest rates just to keep the lights on. That is the situation we find ourselves in today, where more than half of the government budget is devoted solely to servicing our existing debt. It doesn’t exactly inspire confidence among prospective lenders.

ANAEMIC EXPORT EARNINGS

The second major factor behind our abysmal credit rating is our inability to bridge the gap between our exports and imports. Global trade is primarily conducted in US dollars. Since Pakistan cannot print dollars on its own, it has to rely on earning dollars in the international market via exports, so that there is sufficient liquidity in the local currency markets to finance imports.

But Gen Musharraf’s policy of trade liberalisation in 2004 led to an escalation of imports that was not matched by a comparable increase in export earnings.

To make matters worse, after the election of the Pakistan Muslim League-Nawaz government in 2013, Ishaq Dar — the finance minister at the time — pursued a policy of artificially inflating the value of the rupee (ie keeping the dollar/rupee exchange rate below Rs100). This lowered the price of imported goods in local markets, but it also meant that Pakistani exports lost ground to other developing countries with weaker currencies, opening up an even wider chasm between our exports and imports.

That ‘gap’ between our exports and imports adds up to about $30 billion each year. And while remittance earnings help, the government has often financed this deficit by borrowing or burning through its own foreign exchange reserves — neither of which are sustainable solutions.

A country is considered to be macroeconomically stable if its forex reserves can finance, at a minimum, three months’ worth of imports. Pakistan’s foreign reserves currently cover a little over two months of imports, and yet this is the highest our reserves have been in the last three years. Thus, our economy remains at perpetual risk of a balance of payments crisis and debt default.

THE PATH FORWARD

The good news is that there are several technical solutions available that can help alleviate our economic quagmire.

From a tax revenue perspective, it means formally documenting all sectors of the economy and levying appropriate taxes. At the behest of the International Monetary Fund (IMF), the government has belatedly taken some steps in this regard. This includes the launch of the ‘Tajir Dost Scheme’ (TDS) to register retail and wholesale traders, and the passage of agricultural income tax legislation in the provincial parliaments.

However, if the experience of TDS is anything to go by, there is still a long way to go. The scheme has been an abysmal failure — reportedly collecting only Rs1.7 million in taxes in the first quarter of fiscal year 2024-25, as opposed to the target of Rs10 billion.

Similarly, doubts remain over whether the influential landowning class will finally acquiesce to being documented and taxed like the rest of the formal economy.

It’s a mixed bag on the export front, too. On the one hand, the depreciation of the rupee, and the subsequent IMF-mandated (relatively) free-float of the currency, has led to exporters finally benefitting from a more favourable exchange rate.

As a result, there has been an uptick in Pakistan’s exports over the past couple of years, rising by 11 percent in 2023-24 and a further 10 percent in the first seven months of this fiscal year.

On the other hand, the recent rise in exports may be a temporary phenomenon, largely driven by a bumper rice crop and India’s (now-reversed) ban on rice exports. In the longer-term, the gap between our exports and imports remains persistently large, with serious concerns that the subsidies and perks offered to exporters are merely augmenting the bottom line of large industrialists, while having a negligible impact on boosting exports.

For instance, in 2022, the much-touted Export Finance Scheme (EFS) cost the gov­er­nment 83 cents for each extra dollar earned via exports, according to the World Bank.

Subsidies to boost exports are not a negative per se, but they must be tied to key performance indicators, rather than being doled out to the most influential stakeholders.

The spectacular success of the Chinese electric vehicle (EV) industry, for instance, is tied to a government policy of setting benchmark efficiency targets and then awarding positive credits to firms that meet those standards, while simultaneously withdrawing subsidies and eventually penalising firms that fail to meet the specified targets.

THE NEED FOR A NEW ELITE CONSENSUS

However, more than technical solutions, what Pakistan needs is a change in philosophy among its elite.

In development literature, there is a concept of the roving bandit vs the stationary bandit. The roving bandit is one who has little incentive to invest or produce, instead stealing all he can in the limited time available, before escaping the land with his loot in hand.

The stationary bandit, on the other hand, is one who intends to stay in an area for the longer term. He will still steal in the form of taxes, but will re-invest at least part of the proceeds back into the land, knowing that it will eventually benefit him too.

Historically, Pakistan’s elite have behaved more like roving bandits. But it is about time they realised that this country and its 250 million inhabitants are not going anywhere. A more economically efficient and financially stable Pakistan will ultimately also bring them greater prosperity.

So, let’s get our economy out of the junk folder — if not for the sake of the country, then at least for the sake of narrow elite self-interest.

The writer is a journalist and development consultant.
His work can be viewed at asadpabani.substack.com

Published in Dawn, EOS, March 16th, 2025