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ISLAMABAD – With foreign reserves diminishing fast, Pakistan is on the brink of an economic crisis that may force its new government to ask for an unpopular bailout from the International Monetary Fund requiring a sweeping overhaul of the country's economy.
The troubles could inject a new element of instability into the nuclear-armed nation of 180 million people that Washington is relying on to combat Islamic militants at home and to help negotiate an end to the war in neighboring Afghanistan.
Pakistan's foreign currency reserves stood at just $6.4 billion as of May 17, down from more than $14 billion two years ago. That is only enough to cover about 1.5 months' worth of imports while the IMF considers adequate foreign reserves for any country enough to cover three months of imports.
Bottoming out could bring painful consequences: A run on the banks by panicked citizens anxious to convert savings into dollars amid fears of a devaluation, a withdrawal from the stock market, a collapse of economic activity and higher unemployment.
The presumptive head of the new government, former Prime Minister Nawaz Sharif, has made fixing the economy his main priority. But even though a crisis may be only six to nine months away, his incoming government appears hesitant about taking IMF money. They know it will come with conditions attached that would likely stir discontent on the streets, such as raising energy prices and broadening tax collection significantly.
"If we manage for six months, then of course we don't have to go" to the IMF, said Sartaj Aziz, a key economic adviser to the government about to take power. He told The Associated Press that in his view, the country might not need a bailout if it moves quickly enough to boost growth and gets help from key allies such as Saudi Arabia, which would come with fewer strings attached.
Stepping up growth, however, is a daunting challenge in a country plagued by severe electricity shortages and a bloody Taliban insurgency, both of which have hampered economic expansion and foreign investment.
Most experts see another IMF bailout as inevitable and are urging the government to immediately seek at least $5 billion. They worry that any delay in asking for IMF help could spark a crisis of confidence that would snowball.
"The writing is on the wall that Pakistan is going to the IMF. The only thing left is to give a date," said Ashfaque Hasan Khan, head of the business school at the National University of Sciences and Technology in the Pakistani capital, Islamabad.
Khan said the official reserve figure understates the problem because the central bank has also borrowed more than $2.3 billion from commercial banks in the forward swap market to prevent the rupee from depreciating. That means the actual reserve figure is closer to $4 billion, he said.
Adding to those woes, Pakistan has very large debt payments coming due over the next year that will further drain reserves. Most notably, it owes the IMF about $2.5 billion by the end of this calendar year.
There have already been worrying signs in Islamabad, where commercial banks have begun telling customers trying to withdraw dollars that they are not available, or that they need to make a special request. Foreign exchange companies in the capital have also reported a shortage of dollars. Pakistan's two largest cities, Lahore and Karachi, show no sign of similar problems. Khan, however, said that was only a matter of time.
Foreign investment, dampened by both political and economic instability, is only expected to be about 0.5 percent of GDP this fiscal year, while the average emerging market country runs at about 3 to 4 percent, according to the IMF.
Still Aziz, the adviser, said he is hopeful the incoming government can take emergency steps to grow the economy that will help Pakistan avoid going for an IMF bailout, or at least make the loan conditions less painful. He said the government will likely ask Saudi Arabia, a major oil supplier, to defer payments on oil imports.
And he predicted the IMF would impose tough conditions if Pakistan does request a new loan now.
"Not only would we find it difficult to fulfill them, but they would stifle our revival agenda," he said of the expected conditions. "The important thing, therefore, is to try to revive investment and growth."
Since 1988, Pakistan has signed onto eight IMF programs that demanded structural changes in the economy. But it has never managed to resolve its chronic problems.
Sakib Sherani, head of Macro Economic Insights Ltd. in Islamabad, said the government will make a mistake if it delays a request for a new IMF bailout.
"There are structural issues here. No amount of Chinese money or Saudi money can get us out of this," he said.
If Pakistan does have to turn to the IMF, it will bring its own set of challenges.
For one, the country has a patchy track record in upholding promised reforms that secured past IMF loans, including an $11 billion program granted amid the last foreign reserves crisis in 2008. The former government abandoned that program in 2011 because it refused to carry out the strict financial reforms required by the IMF. But it still owes the lending agency nearly $5 billion from that old loan.
The new government will have to convince the IMF with quick actions that this time around will be different. The IMF will want to see far-reaching reforms fast-tracked to reduce the chance of another reversal part way through a multi-year program.
And the lending agency is expected to demand vast improvements in a woeful tax system that collects very little money. Taxes currently bring in only about 10 percent of gross domestic product, one of the lowest effective rates in the world.
The IMF is also likely to press for major changes in the energy sector such as raising prices and phasing out costly subsidies that disproportionately benefit the wealthy, who use far more energy than the poor. The government spends about $1 billion in foreign currency each month to import oil to run its power plants — a costly way to generate electricity and another drain on foreign reserves. Building new hydroelectric plans or converting to less expensive natural gas production would be very expensive and take years.
The IMF is also expected to demand some kind of plan to curb losses from state-owned enterprises that amount to billions of dollars a year.
Pakistan's budget deficit — the difference between what it spends and takes in — is expected to be at least 7 percent of GDP this year. The IMF does not consider that sustainable and would likely press for a scaling back to about 3-4 percent of GDP.
The economy is expected to grow around 3.5 percent for the fiscal year ending June 30, and though that figure may look good in comparison to Europe or America, it is less than half the rate needed to supply jobs to the growing population. And it is also low by historical standards. Aziz said growth from 1960-2010 averaged about 5.5 percent annually but in the last five years, it slowed to 3 percent.
Despite the enormous challenges, there are some in Pakistan who remain sanguine that an IMF bailout will come through no matter what because the U.S. — the largest shareholder in the organization — considers Pakistan too strategic to fail.
"By now, just about everybody knows that it's U.S. strategic interests that dictate the disbursement of this money and not really any progress or timeline on reforms," said Khurram Husain, a business columnist for Pakistan's Dawn newspaper.
Olster reported from Washington.