Is it possible that Pakistan has scored a self-goal by allegedly sponsoring last week’s terrorist attack on Indian security forces in Pulwama, Jammu & Kashmir which took over 40 lives? Since the Pakistan-based terrorist group Jaish-e-Mohammad (JeM) has claimed responsibility for the attack, India has vowed to work on isolating Pakistan economically and diplomatically as a state sponsor of terrorism. This comes at a time when Pakistan is facing an external payments crisis, with only $7 billion in reserves, less than two months of import cover, and is in desperate need of a bailout by the International Monetary Fund (IMF). Yet, if India succeeds in convincing major shareholders of the IMF — the US, European countries, Japan and China — and international organisations like the Financial Action Task Force (FATF) of the Pakistan state’s involvement in these attacks, an IMF bailout of Pakistan, which looked like a distinct possibility just last week after the meeting between Pakistani prime minister Imran Khan and IMF managing director Christine Lagarde, could be in jeopardy. And Pakistan risks going over the precipice as a result.
Outwardly, Pakistan is putting up a brave face and appears to have got a reprieve with the Saudi Crown Prince Mohammed bin Salman promising investments up to $20 billion during his recent visit there in what has widely been interpreted as help for the country’s crumbling economy. However, these are just pledges of potential future investment, and even if they materialise, funds will flow slowly as projects get grounded. Despite the fanfare of Prime Minister Khan and the crown prince cheerily driving through the streets of Islamabad in a horse-drawn carriage, the promised Saudi assistance will do little to rescue Pakistan from its rapidly deepening balance of payments crisis.
The need to access IMF assistance is a sharp brush with reality for Prime Minister Khan who, as is typical across South Asia, won office on the promise of huge handouts. Early in his tenure, Khan exuded confidence that friendly countries such as Saudi Arabia, the UAE and China would come to his aid, thereby helping him avoid going to the IMF and escape the harsh conditionalities that will accompany an IMF package, including stringent expenditure cuts. Evidently, those hopes have not materialised to the extent expected, leaving the prime minister — who once said he would rather commit suicide than approach the IMF — with little choice but to negotiate with the IMF for Pakistan’s 12th bailout package since the 1980s.
Even before the Pulwama attacks, there were difficult issues that Pakistan needed to settle with the Fund. One of the main issues is providing the IMF with concrete assurance that its assistance will not be used to repay Chinese loans. The IMF is likely also demanding a meaningful float of the exchange rate, which Pakistan will find difficult to yield on, in part out of fear of financial instability. Pakistan has already raised gas and electricity prices, but the Fund will likely go beyond just utility prices and seek a comprehensive fiscal responsibility package from the government to ensure that its assistance will pave the way for restoring credibility to public finances.
In Pakistan, as across emerging and developing economies, the IMF is seen as a necessary evil — to be approached as a last resort when all other avenues of resurrecting a sinking economy fail. Despite the fear of domestic political backlash to IMF loan conditionalities, Pakistan’s recent experience demonstrates the critical importance of an arrangement with the IMF for an economy in crisis. It is only an IMF package that sends the signals that can restore investor and market confidence in a flailing economy and enable a sustainable adjustment. But the reverse is also true: If institutions such as FATF continue to keep Pakistan on the grey list or even blacklist it, and the IMF imposes more stringent conditionalities or even significantly delays its loan agreement, global investor confidence in Pakistan could nosedive, deepening the economic crisis.
On the political side, before the Pulwama attack, Pakistan’s negotiating strength vis-à-vis the IMF seemed to have been improving. The US is currently focused on securing a peace deal with the Taliban in order to leave Afghanistan, and Pakistan’s support is crucial for concluding the deal. In return for that support, the US, as the dominant shareholder in the IMF, would have put its formidable weight behind a Fund bailout package for Pakistan. In the wake of the Pulwama attack, Pakistan may have forfeited that support. The US has endorsed India’s right to self-defence and, in a clear signal that it is not willing to look the other way from Pakistan-based and possibly-supported terrorist group attacks, it has asserted that Pakistan must crack down on terrorists operating from its territory, as per its obligations under UN resolutions.
Has Pakistan overplayed its hand? Will its worsening economic crisis help it realise that the price to pay for sponsoring terrorism can be exceedingly high? How Pakistan responds to these questions will determine the chances for peace in the Subcontinent.
This article first appeared in the print edition on February 21, 2019, under the title ‘The cost of Pulwama’. Mullen is Visiting Senior Research Fellow and Subbarao is Distinguished Visiting Research Fellow at the Institute of South Asian Studies, National University of Singapore.