Crisis ahead!

Political crisis and economic pressure make for a deadly cocktail. Sri Lanka and Lebanon provide an example of what can happen if gridlock prevents a government from taking timely action to avert catastrophic meltdown.

 Imagine a patient with elevated levels of blood sugar. If said patient does not change course quickly and take the prescribed medication, complications set in. Ignore those complications and the patient’s life is at risk. The economy of a country functions in a similar way: ignoring early warning signs and doubling down on poor decisions can lead to contagion, turning what was once a relatively manageable situation into a multi-headed hydra threatening the very foundations of a nation-state. With no functioning federal government, about two months of import cover, and a disastrous policy to freeze energy prices in effect, Pakistan is staring into the abyss. Immediate course correction is needed, but an ongoing political and constitutional crisis means that there is no captain to steer the ship into steady waters.

Sri Lanka offers an example of what happens when crises mutate at an exponential rate. The island nation has been facing external sector challenges for several years, with the coronavirus pandemic worsening the situation as dollar inflows from tourism dried up. Astute policymaking at that time could have stabilized the situation, but the Rajapaksa regime, where the family itself dominated decision-making, kept doubling down on one bad policy choice after another. An example was the ban on chemical fertilizers which led to farmer protests and a dramatic decline in the output of key products including tea and rice. With reserves collapsing, the regime delayed negotiating with creditors and the IMF; the country ultimately was left with about $2 billion in reserves and $7 billion in debt repayments due in 2022.

What was initially a balance of payments crisis has quickly turned into socio-political one. The foreign currency has collapsed in value, declining by over 30 percent year to date, making it the worst world’s worst-performing currency. The shortage of foreign currency means that the country is now rationing power, with the country’s public utilities announcing power cuts of up to 6.5 hours a day from April 6 to April 8. Petroleum products are in short supply and essential food items are not readily available in markets; inflation clocked in at 19 percent in March, the highest in Asia.

Sick and tired of the pain, Sri Lankans have taken to the streets, protesting outside Rajapaksa’s home, clashing with police. As the situation has worsened, the government declared an emergency and restricted access to social media to stop the protests, but this did not help. By the time Rajapaksa decided to bring the opposition parties together, it was too late. The government’s own allies have dissented, Rajapaksa is being told to resign, and Sri Lankan society is facing unprecedented upheaval.

Lebanon is another example of how unresolved economic and political crises can exponentially mutate and lead to widespread chaos. What the World Bank referred to as one of the worst financial crises in centuries did not happen overnight. Political tensions in the region, starting with the civil war in Syria, set things off in motion. Lebanon’s central bank offered higher interest rates on dollar deposits, but these returns were paid for by money coming in from new deposits, as Lebanon was not earnings enough dollars to pay these rates. Eventually, people caught on, and in 2019 things started to get out of hand.

As a result, Lebanon’s real GDP declined by 21.4 percent in 2020 and 10.5 percent in 2021. The currency has lost over 90 percent of its value against the dollar on the black market. Inflation soared to 145 percent in 2021, which was the third-highest rate in the world behind Venezuela and Sudan; in February 2022, inflation came in at 215 percent. Short of funds, the government proposed new taxes, including a tax on WhatsApp calls, which fueled further anger on the streets.

The pandemic dried up tourism revenues and a major explosion at Beirut port highlighted how basic governance was collapsing due to the ongoing crisis. Essential products have been tough to get a hold of, with recent reports indicating that flour mills in the country have shut down, threatening over 50 percent of the country’s flour supply. The country is negotiating a program with the IMF to stabilize its economy and the government has defaulted on over $30 billion of its external debt. The total financial losses from the crisis are estimated to be about $69 billion and it is facing renewed pressures due to rising commodity prices. Lebanon, once the success story in the region, has now become a basket case.

This is not to say that Pakistan is facing the same nature and scope of the crises faced by Sri Lanka and Lebanon. The point is that political uncertainty, paired with populist economic decision making and external sector pressures, can quickly mutate into socioeconomic crises. With the Imran Khan government deciding to freeze energy prices and bringing about a constitutional crisis, the country’s risk premium in the international bond market has reached its highest levels since 2013. Two months of import cover means that finding an influx of dollars is going to be an urgent necessity. All of this must be done at a time when the country is deeply divided and there is an ongoing political and constitutional crisis.

Making tough decisions to bring about some level of stability in the macroeconomy within this context is going to be a Herculean task. It will require a government to bear serious political costs and face unprecedented societal pressure, all while moving the political process along through to elections. All in all, the country’s political and non-political elite have their work cut out from them, and it is about time they resolve their political differences and focus on the emerging economic crisis. Any further delay risks socioeconomic chaos.