Will a fresh IMF loan provide temporary relief to Pakistan’s crumbling economy?

Two countries were founded in 1947 in South Asia, India and Pakistan. Like the eminently popular Bollywood movies from India, which often tell contrasting stories of two siblings, these two countries have followed different trajectories since Independence.

While India went on to build itself as a functioning democratic powerhouse and is set to overtake Japan to become the fourth-largest economy in 2025, the other, Pakistan, remains mired in an economic crisis, wreaked by poor fiscal and social indicators and crumbling under the weight of its army’s jihadi policies.

India’s robust democratic institutions, coupled with its focus on economic growth and reforms over the years, have worked in its favour, while Pakistan’s fragile democracy—marked by coups, military involvement in politics and deep social inequality—has proved to be a major stumbling block to its economic development. Pakistan’s gross domestic product (GDP) is approximately 0.33% of world's GDP, as per the International Monetary Fund (IMF). Despite the small size, its economy has remained unstable and hasn’t been able to develop resilience.

Pakistan’s latest loan from the IMF is the 25th since its inception and the highest number of times that any country has approached IMF for assistance. It currently owes the IMF over $8 billion. Experts believe that going by its past, it is unlikely to lead to a substantial improvement in its economy.

Unlike India, Pakistan has historically been dealing with an unstable political environment and an all-powerful military. The situation has worsened since the Covid-19, with debilitatingly high external debt, low growth of less than 3%, record-high unemployment, and inflation that rose to 40% in May 2023, all of which snowballed into the economic crisis of 2024, bringing the country again to the brink of a sovereign default.

The situation has been exacerbated by the impact of climate change, which has led to extreme weather events, such as devastating floods, which pose yet another challenge to Pakistan’s already struggling economy. “Worsening water scarcity and growing climate vulnerability compound the crisis. While Pakistan urgently needs investment in climate adaptation, limited fiscal space leaves the government ill-equipped to respond. Without bold and comprehensive reform, the country risks being trapped in a recurring economic breakdown and fragile recovery cycle,” says Soumya Bhowmick, an Indian economist.

Climate change is a global issue, and India too hasn’t escaped unscathed. However, compared to Pakistan, India’s problems are less severe and it has adequate internal resources to deal with these on its own. Bhowmick says that Pakistan’s economy has a multi-dimensional crisis beyond temporary macroeconomic shocks. “At its core are deep-rooted structural weaknesses: a narrow tax base, stagnant industrial and agricultural productivity, chronic energy dependence, and weak institutional capacity,” he says.

India’s former finance secretary Subhash Chandra Garg agrees that Pakistan’s economy has been mismanaged. “It used to be a multiple of Bangladesh’s economy when Bangladesh got independence. A few years back, Bangladesh overtook Pakistan’s GDP,” he says.

According to him, the current state of Pakistan’s economy is the result of a combination of factors. These include the absence of good business and industrial entrepreneurship, high military interference, repeated involvement in conflicts, the dominance of Sharia, blasphemy, and other religious laws on the business environment, sustenance of terrorism and terrorist infrastructure, and suppression of democracy, among other things.

IMF TO THE RESCUE

In 2024, Pakistan’s fast-depleting foreign exchange reserves brought to the fore concerns about its ability to service its external debt obligations worth $131 billion by the end of the year. With increasing pressure and import restrictions threatening its domestic industries, it was once again IMF to the rescue. Pakistan received a stand-by arrangement (SBA) that helped the country meet financing gaps and restore confidence, allowing for the easing of import controls. Then, in September of that year, the IMF Executive Board approved a $1-billion loan for Pakistan as a 37-month extended arrangement under the Extended Fund Facility (EFF) to address its longer-term problems and achieve economic stability and growth. The results? The GDP growth rebounded to 2.5% in FY24 from 0.29% in FY23, and 2.6% in FY25. Consumer price inflation, which was 23.4% in FY24, is forecast to ease to 5.1% in FY25. In recent months, its inflation rate declined to 0.7% year-on-year in March 2025, marking the lowest level in nearly 60 years. It further decreased to 0.3% in April 2025, a new historic low. This resulted in a moderation of the policy interest rate, and partial restoration of investor confidence.

The IMF noted the improvement in its Executive Board meeting on May 9 this year for the first review of Pakistan’s economic reform program under the EFF Arrangement. The IMF approved a fresh $2.4 billion package to Pakistan, including an immediate disbursement of around $1 billion and an arrangement under the Resilience and Sustainability Facility (RSF), allowing access to about $ 1.4 billion.

“Pakistan’s policy efforts under the EFF have already delivered significant progress in stabilising the economy and rebuilding confidence, amidst a challenging global environment,” the IMF said in its press release.

At the meeting, India raised concerns over the efficacy of IMF programmes in the case of Pakistan due to its proven inability to deliver results and abstained from voting. “In the 35 years since 1989, Pakistan has had disbursements from the IMF in 28 years. In the last five years since 2019, there have been four IMF programmes. Had the previous programmes succeeded in putting in place a sound macroeconomic policy environment, Pakistan would not have approached the Fund for yet another bailout programme,” India had said at the board meeting. According to Garg, who also served as an executive director at the World Bank, only the US has effectively a veto in the IMF. “If the US did not want the IMF to do this operation, IMF would not have brought it to the board at all,” he says, pointing out that this has been the case for Russia and Iran. The IMF did not respond to a detailed email query sent by Business Today on the bailout package to Pakistan.

COST OF WAR

Pakistan’s survival is dependent on loans. The recent escalation with India has also raised questions over its priorities and the impact this war-like situation has on its economy and investor confidence.

“Sustained escalation in tensions with India would likely weigh on Pakistan’s growth and hamper the government’s ongoing fiscal consolidation, setting back Pakistan’s progress in achieving macroeconomic stability,” warned a recent report by Moody’s Ratings.

Pakistan’s macroeconomic conditions have been improving, supported by assistance from the IMF and other multilateral agencies, with growth gradually rising, declining and foreign exchange reserves increasing amid continued progress under the IMF programme, the report highlighted. However, it also cautioned that a persistent increase in tensions could also impair Pakistan’s access to external financing and pressure its foreign exchange reserves, which remain well below what is required to meet its external debt payment needs for the next few years.

A report by JM Financial noted that the impact of India-Pakistan conflicts on India’s economy has been far greater. “It is also pertinent to note that the Indian economy now is far larger and more resilient than what it was during previous conflicts,” it said.

The report states that during the Indo-China war of 1962, India’s GDP declined by 0.8%, while India’s GDP declined 2.6% in 1965, post the Indo-Pak war in 1965, after growth of 7.5% in FY64-65.

Though India’s GDP growth did not contract during the 1971 Bangladesh liberation war, there was a slowdown. GDP growth in FY71-72 declined to 1% from 5% in FY70-71, according to the JM Financial report. Only during the year of the Kargil war did the economy saw an increase in GDP growth (8.9%) as compared to 6.2% in 1998, the report noted.

A closer look at the two economies shows that India is significantly ahead of Pakistan on almost all major indicators. According to the IMF, India’s GDP of $3.9 trillion in 2024 is over 10 times that of Pakistan’s, which was at $373 billion in 2024. Similarly, the combined market capitalisation of the top 10 Indian firms is three times that of Pakistan’s GDP. Pakistan’s private sector is widely viewed as being significantly “constrained.” The World Bank’s Country Partnership Framework for FY26 to FY35 highlights that this is “due to a cumbersome regulatory environment, large state- and state-owned firms, limited financial markets depth, distortions in pricing and tax incentives, high government borrowing that crowds out private credit, and an anti-export bias in trade policies.” The recent escalation is expected to increase military spending by both countries. For India—currently the fastest-growing major economy in the world with GDP growth projected at 6.5% this fiscal, adequate forex reserves of $686 billion as of May 2, and robust investor interest—the impact of this conflict may be limited.

While there’s no exact estimate on the cost of war, defence expenditure continues to be huge for both India and Pakistan, although the latter can hardly afford it. As per the Stockholm International Peace Research Institute, India’s military expenditure, the fifth largest globally, grew by 1.6% to $86.1 billion in 2024. Meanwhile, Pakistan spent $10.2 billion, significantly lower than India’s spend.

On the face of it, the amount appears less but given the state of Pakistan’s resources, it’s a significant part of its annual spending. Pakistan’s total expenditure was Pakistani Rs 17.2 lakh crore for FY25, of which 42% or Pakistani Rs 2.12 lakh crore is earmarked for defence and military expenditure and Pakistani Rs 9.7 lakh crore for servicing debt payments. That would leave Pakistani Rs 28.17 billion for health, Pakistani Rs 103.7 billion for education, and Pakistani Rs 608 billion for social protection.

REFORMS ON THE BACKSEAT?

The IMF’s aid to Pakistan is tied to fiscal deliverables and reforms to improve its economic parameters and ensure financial independence. Key priorities as part of the EFF programme for Pakistan include macroeconomic sustainability through consistent implementation of sound macro policies. The Pakistan government in December 2024 launched an ambitious five-year economic transformation plan called Uraan Pakistan: Homegrown National Economic Plan. As part of this, Pakistan aims to achieve a sustainable GDP growth rate of 6% by 2028 and one million jobs annually along with $10 billion of private investments every year. It would also introduce schemes that would help achieve $60 billion in exports by the end of FY28, nearly double the $30.64 billion in merchandise exports in FY24. As of now, its key exports include textiles and garments, agri goods like rice and cotton. The US and the UK are its major trade partners.

Poverty also remains a real challenge for Pakistan with an estimated at 25.6% people below the poverty line in FY25, according to the World Bank. With stagnant real wages and population growth of around 2%, another 1.9 million more individuals will be pushed into poverty, warned the World Bank’s Pakistan Development Report released in April 2025. Only 2.5% of its total population pays income tax, highlighting the country’s deeply imbalanced socio-economic structure. Direct taxes are estimated at just Pakistani Rs 5.5 trillion in FY25 in its total tax collection of Pakistani Rs 12.97 trillion for the fiscal. High unemployment of over 8% and an employment-to-population ratio of 49.7% reflect low labour market engagement, particularly among youth and women.

Concerned about the conflict with India, the IMF too has noted that “rising tensions between India and Pakistan, if sustained or deteriorate further, could heighten enterprise risks to the fiscal, external and reform goals of the program”. It has also highlighted reputational risks that could come from any perceived lack of even handed or if there was a perceived misuse of Fund disbursements and has set 11 new conditionalities for the latest loan. These include Parliamentary approval for tis Federal Budget in line with the IMF loan facility by June 2025, implementing the new agricultural income tax through a comprehensive plan and a higher debt servicing surcharge on electricity bills.

India found itself in a similar position in the past. In 1991, when the country embarked on reforms to open and liberalise the economy, it made a clear choice for growth and prosperity after it had to seek an emergency loan from the IMF by pledging a part of its gold reserve.

For Pakistan, fixing its economy and addressing the terror challenge would be critical in coming times.

@surabhi_prasad, @iamrahuloberoi