From Colombo to Islamabad - A steep rise in inflation will create a potent mix that could easily lead to social unrest in the country.

By Aqdas Afzal

SHOCKING images of torched trees, smoldering greenbelts, and burnt-out vehicles are not something that people associate with Islamabad. But, in the history of a nation, capital cities have often become the battleground for disparate political forces.

Baghdad, Delhi and Istanbul have seen a lot of violence through the centuries. One hundred years ago, Benito Mussolini marched on Rome with 30,000 followers. Of late, Colombo, the capital of Sri Lanka, has become the staging ground for daily protests by the public and marches against a complete and utter economic meltdown.

Given this tumultuous history of capital cities, will Islamabad too suffer the same fate? The answer lies in whether the current government will be given the time, support and space to implement some important economic decisions that are urgently required to prevent the economy from spiralling out of control.

Since the start of hostilities between Russia and Ukraine, developing countries such as Pakistan have been facing severe external account pressures mainly on account of the steep increase in the price of oil in the international market. State Bank data reveals that petroleum group imports cost 91pc more in the first 10 months of this fiscal year. This steep escalation in the import bill has resulted in Pakistan losing 50pc of its foreign exchange reserves in the last nine months, leaving import coverage of only about 1.5 months at best.

A steep rise in inflation will create a potent mix that could easily lead to social unrest in the country.

Oil prices are not going to come down anytime soon. As the European Union moves to ban Russian oil imports, some analysts believe that Russia may try to punish Europe by curtailing production, thus raising international oil prices in order to inflict maximum damage on European economies. Some market analysts are warning investors to brace themselves for an economic ‘hurricane’ that may push oil prices to as high as $175 per barrel.

With no end to the oil price escalation in sight, and with rapidly depleting reserves, the government was forced to go to the IMF. However, the IMF had already indicated that in order for talks to be fruitful, this government would have to reduce the fiscal deficit by passing on the rise in oil prices to the people. This put the government between a rock and a hard place.

It is believed by many that political stability and economic growth are deeply interconnected as political uncertainty and social unrest lead to lower levels of investment and growth. Recent economic crises in countries such as Lebanon and Sri Lanka can be traced to internal political instability. Specifically, as economic crises start taking shape, governments at times exacerbate crises by trying to avoid or control political instability or by simply making poor economic decisions under political pressure.

Many economists recently criticised the government for not passing on the rise in international oil prices to consumers, with many commentators blaming it on the government’s indecisiveness. But there is evidence to suggest that the government had a fair idea about the worsening economic situation since the contours of the crisis were visible as early as February this year. The government, for instance, was very quick in tapping Miftah Ismail for the finance portfolio, even when the rest of the cabinet had not been announced. Still, the government dithered on passing on the prices until the political storm had blown over in Islamabad.

Perhaps, the government was correct in waiting for the political situation to settle down as passing on the price increase would surely lead to back-breaking inflation. It is very likely that inflation will touch 18pc to 20pc this calendar year, given how international oil prices are going up. In a politically volatile environment, passing on a massive price increase to the people would be akin to fanning the flames of social unrest.

To be sure, the government was evaluating an increase in fuel prices after the political volatility reached its climax with the in-house change in the National Assembly. Political volatility has not since abated, especially as the Punjab chief minister remained unsuccessful in announcing his cabinet until very recently.

Though there are indications of near-successful negotiations between the IMF and the government, Pakistan’s economy is not out of the woods. On the external front, the economy is facing extremely strong headwinds in the shape of continued pressure on foreign exchange reserves coming from elevated oil prices, as well as from rising policy rates in developed economies.

Additionally, Pakistan’s export destinations are experiencing stagflation, ending all hope of exports bailing us out. On the domestic front, a steep rise in inflation will create a potent mix that could easily lead to social unrest, thereby making it difficult for the government to take optimal economic decisions. In a sense, a severe economic crisis coupled with political instability could very well turn into a vicious cycle, whereby Pakistan starts hurtling towards a hard default like Sri Lanka.

Nevertheless, a hard default can be avoided. But in order to do that, unpopular economic decisions will need to be taken such as passing on oil price increases, having more import controls and possibly even fuel rationing. Given this very challenging economic scenario, political stability is the need of the hour. Forcing the government to call elections in the midst of a devastating economic crisis will only serve to increase political instability as different parties may decide to face off in the streets of Islamabad.

Moreover, the IMF and other international lenders may be reluctant to talk and provide assistance to a caretaker government, given there is no guarantee that the caretakers’ promises would be honoured by the next government. The fate of Islamabad and that of Pakistan’s economy is going be determined by political continuity and stability.

https://www.dawn.com/news/1692899/from-colombo-to-islamabad