Pakistan’s Economic Flaws Catch Up to Bite Defence Needs

For its 2022-2023 fiscal budget, the Pakistani government announced that it will raise the defence budget by 2.69% compared to the revised 2021-2022 budget. This amounts to PKR 1.52 trillion, or around $7.46 billion U.S based on today’s currency exchange rate.

The key issue with this year’s defence budget is that in terms of foreign or hard currency, it has less value compared to last year’s defence budget. For 2021-2022, the government allocated PKR 1.29 trillion, which had amounted to $8.78 billion U.S because, at that time, the PKR held a higher value.

Thus, when it comes to its capacity to purchase defence items from abroad, the Pakistani budget is about 15% less (i.e., the dollar or foreign currency value) compared to last year.

In fact, the Pakistani government cited inflation as a key reason for raising the defence budget. While the cost of domestically produced goods is up, the cost of imports rose exponentially more due to the fall in the value of the Pakistani rupee. Thus, the fiscal defence budget hike was aimed at offsetting the monetary fall of the rupee and, in turn, maintain the military’s ability to import key items.

However, this budget increase did not offset the fall of the rupee. Pakistan is working with 15% in the way of USD. This is a significant drop, and it will certainly hamper Pakistan’s ability to import big-ticket defence items, such as fighter aircraft, surface warships, submarines, armoured vehicles, and other assets.

In other words, one can reasonably expect the purchasing power fall to hamper Pakistan’s modernization efforts for this upcoming year. But the critical issue to monitor is how Pakistan navigates this challenge in the next three to five years, if not longer. If Pakistan has to slow or pause its procurement projects, then it is unlikely to re-accelerate in this decade unless it drastically boosts defence spending.

Structural Economic Flaws Come to Bear

In a previous article, Quwa discussed that Pakistan struggled with defence modernization due to the rising cost of procurement. The cost of procurement is not only driven by the innate increase of the good itself (due to a higher degree of technology use, for example), but a constantly depreciating PKR as well.

On the surface, the depreciating PKR is a result of Pakistan needing more foreign currency for importing compared to the world market needing PKR to drive Pakistani exports.

For example, if Pakistan had been an oil exporter, there would be more demand for the PKR. These other countries would sell their own currencies in order to buy PKRs. In turn, the amount of PKRs drops, and the quantity of the other currencies go up. Thus, the value of the PKR goes up relative to the other currencies.

Practically, Pakistan would ask for USD, British Pounds, or Euros for its goods. Thus, countries would send that currency to Pakistan for its goods. In turn, there is more of USD et.al in Pakistan and, therefore, the value of the PKR relative to the USD goes up. This is assuming only pure market dynamics are at play.

Pakistan is not an energy exporter. But this is the critical issue. Pakistan is not an exporter of a high-value, high-demand good. Thus, it is not generating enough foreign currency gains to compensate the cost of its imports, which include defence items, energy, luxury goods and much more.

Moreover, to fund its fixed – or increasing – import needs against a diminishing PKR, Pakistan takes loans. Not only does Pakistan have to directly repay these loans in a foreign currency (and with interest no less), but this payment can count as a currency outflow (further weakening the PKR).

In addition, the continuing reliance on imports stops the domestic market from correcting itself. Basically, the market does not have an incentive to locally produce what it can import. The importing itself is not an issue, but that it occurs in an artificial way (e.g. the use of loans to prop up the PKR).

In effect, the ‘import culture’ stymies competitive domestic industries that could have emerged to support local demand. If these industries were competitive enough, they could drive exports and currency gains.

Eventually, Pakistan will have to ‘live within its means,’ and this reality will affect defence procurement.

The Cost of Not Linking Defence to Economy

This exposes a structural economic problem. However, from a defence standpoint, this problem exposes a deep flaw: the disconnect between defence policy and economic policy.

Be it because of a lack of acknowledging the economy’s value, not understanding how to sustainably grow an economy, or ignoring economic management, the disconnect will severely hurt procurement.

Realistically, there is no short-term solution (aside from a windfall like military aid). Even if Pakistan builds a strong policy foundation and aggressively ties its defence and economic interests, it will not see a great payoff for at least some years (at least a decade for some industries).

Pakistan’s defence planners might have hoped that China Pakistan Economic Corridor (CPEC) would help build those links and enable defence spending growth. However, CPEC was poorly defined and, at its best, “put the cart before the house” by front-loading infrastructure without there being demand for it.

Rather, the correct policy was to create the demand for roads and powerplants, and then build the assets in accordance with the growth of those needs.

For example, Pakistan should have invested in upskilling its labour through training and education. Doing so would allow Pakistan to compete for foreign investment in manufacturing, software development, IT, services outsourcing, and much more. When those industries grow and demand a greater use of existing infrastructure, that is the point when a program like CPEC would have made sense.

This discussion matters to Pakistan’s defence woes because had there been more export-oriented growth (especially in manufacturing and other high-value sectors), it would have foreign currency. In turn, it could leverage the stronger PKR to sustain more defence imports. One can see that Indonesia and Malaysia had taken this approach and, thus, are able to sustain their defence spending.

Likewise, not connecting defence policy with economic policy has also stymied the local defence industry, especially the private sector. To its credit, it seems the Pakistan Air Force (PAF) is trying to course-correct, but even its initiatives are not linked to broader nation-building policies.

For example, had Pakistan upskilled its population, it would have a more capable labour pool to lean on for cutting-edge R&D and high-tech manufacturing. So, in the case where the country has to invest in high-tech sectors itself (instead of relying on foreign direct investment), it would have a starting base. Not only could these investments enable Pakistan to substitute some imports, but it could also export solutions.