Order Code RS22983
Updated November 21, 2008
Pakistan’s Capital Crisis:
Implications for U.S. Policy
Michael F. Martin and K. Alan Kronstadt
Analyst in Asian Trade and Finance and Specialist in South Asian Affairs
Foreign Affairs, Defense, and Trade Division
Summary
Pakistan — a key U.S. ally in global efforts to combat Islamist militancy — is in
urgent need of an estimated $4 billion in capital to avoid defaulting on its sovereign
debt. The elected government of President Asif Ali Zardari and Prime Minister Yousaf
Raza Gillani is seeking short-term financial assistance from a number of sources,
including the International Monetary Fund (IMF), China, and an informal group of
nations (including the United States) known as the “Friends of Pakistan.” The Pakistani
government reportedly has reached a tentative agreement with the IMF for $7.6 billion
in loans, but has reservations about conditions on the assistance, expressing concerns
that they may create political and economic problems. The current crisis has placed
some strain on U.S.-Pakistan relations. This report will be updated as circumstances
warrant.
A stable, democratic, prosperous Pakistan is considered vital to U.S. interests.1 U.S.
concerns regarding Pakistan include regional and global terrorism; Afghan stability;
democratization and human rights protection; the ongoing Kashmir problem and Pakistan-
India tensions; and economic development in the region. Progress in this latter area has
been severely threatened in 2008 by a sharp decline in Pakistan’s economic stability,
culminating in an immediate need for capital assistance. U.S. officials and independent
analysts are increasingly concerned that a failing Pakistani economy could undermine
multilateral efforts to stabilize South Asia and curtail the incidence of Islamist radicalism.
After several years of strong and comparatively stable growth, Pakistan quickly slid
into a severe economic crisis in 2008 (for reasons discussed later in the report). Real GDP
growth has slowed from 7%-8% per year since 2004 to an estimated 3%-4% in 2008. Its
official rate of inflation rose from 8.8% in January to 23.9% in October.2 Since the
beginning of the year, the Pakistani rupee has depreciated by over 23% against the U.S.
1 For more information about U.S.-Pakistan relations, see CRS Report RL33498, Pakistan-U.S.
Relations, by K Alan Kronstadt.
2 Data from the State Bank of Pakistan web page, [http://www.sbp.org.pk/ecodata/pricei.pdf].

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dollar, leading to rising trade and current account deficits. During the summer of 2008,
apparent capital flight added downward pressure on the rupee, worsening Pakistan’s
capital account deficit and accelerating the decline in the nation’s foreign exchange
reserve holdings — leading to the possibility that Pakistan could default on its sovereign
debt obligations.3
Since his ascension to the presidency in September 2008, President Zardari has
attempted to address Pakistan’s economic problems, with the support of his chief
economic advisor, Shaukat Tarin. On September 19, 2008, acting finance minister Naveed
Qamar released new economic policies designed to bring about macroeconomic stability
and avoid seeking IMF assistance that included the elimination of fuel, electricity and
food subsidies, and a reduction in the government deficit.4 On November 3, 2008, Tarin
announced reforms of Pakistan’s tax system, including the politically sensitive taxation
of large landowners, to reduce the incidence of tax evasion.5 President Zardari has
emphasized the importance of his nation’s economic problems, stating, “The greatest
challenge this government faces is an economic one.”6
Despite the September announcement of new economic policies, Pakistan’s foreign
exchange reserves have continued their year-long decline. The State Bank of Pakistan’s
holdings of foreign exchange reserves fell from $14.2 billion at the end of October 2007
to $4.1 billion at the end of October 2008.7 Of immediate concern, Pakistan reportedly
needs $4 billion to $5 billion in assistance by the end of November in order to avoid
defaulting on maturing sovereign debt obligations. According to Tarin, Pakistan will need
$10 billion to $15 billion over the next two to three years to continue to service its capital
account deficits and its outstanding debt.8
The Immediate Task: Capital to Cover Debt
During September and October, Pakistan sought assistance from a number of
sources, including the Asian Development Bank (ADB), China, the IMF, Saudi Arabia,
the United States, and the World Bank. To date, Pakistan has been unable to secure a firm
commitment for support from most of these sources.
Plans A and B. Pakistan’s initial approach, termed “Plan A,” was to obtain loans
from selected sources, such as the ADB, the World Bank, the United Kingdom’s
Department for International Development (DFID), and the Islamic Development Bank
3 “Flight of Capital to Dubai on the Rise: PEW,” The Post, August 25, 2008.
4 “Pakistan Unveils Package for Economic Stability,” Reuters, September 19, 2008.
5 Farhan Bokhari, “Pakistan Vows to Target Rich Tax Evaders as IMF Concludes Talks on Vital
Loan,” Financial Times, November 3, 2008.
6 “Pakistan’s Zardari to Give Up Powers,” AFP, September 20, 2008.
7 Data from the State Bank of Pakistan web page, [http://www.sbp.org.pk/ecodata/forex.pdf].
8 Simon Cameron-Moore, “Pakistan Needs $10-15 Bln Fast, Says PM’s Adviser,” Reuters,
October 21, 2008.

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(IDB).9 The ADB did agree to provide Pakistan with a $500 million loan “to address
harm done to poor families and the country’s economy by unprecedented international
food and fuel price hikes.”10 In addition, the World Bank originally offered $1.4 billion
in assistance.11 However, the combined ADB and World Bank loans are insufficient to
address Pakistan’s current capital shortfall.
When Plan A proved unworkable, Pakistan shifted to Plan B, which was to secure
commitments for support from an informal group of nations known as the “Friends of
Pakistan.” On September 26, 2008, a group of nations met President Zardari in New York
City to discuss ways to support Pakistan with its political, economic, and security
problems. Zardari reportedly sought $100 billion in aid from the group.12 Calling
themselves the “Friends of Pakistan,” the informal coalition includes representatives from
11 nations (including China, Saudi Arabia, and the United States), as well as the European
Union, the United Nations, and the IMF. The group did not, however, offer Pakistan any
financial support following their September meeting. At the second meeting of the
Friends of Pakistan (held on November 17, 2008 in Abu Dhabi), Pakistan again requested
assistance, but no commitment to aid was forthcoming.
China. As part of the Plan B initiative, President Zardari traveled to Beijing in mid-
October to strengthen ties between the two nations, as well to ask for financial assistance.
Following a meeting between President Zardari and China’s Premier Wen Jiabao, a
spokesperson for China’s foreign ministry stated, “As a long-time friend of Pakistan,
China understands it is facing some financial difficulties. We are ready to support and
help Pakistan within our capability.”13 Although China provided no further details on the
form and extent of its intended support to Pakistan, they did agree to foster closer
economic relations between China and Pakistan, setting the goal of increasing bilateral14
trade from $7 billion in 2007 to $15 billion in 2011.15 On November 14, 2008, China
pledged to provide Pakistan with $500 million in financial assistance.
Saudi Arabia. President Zardari and Tarin left for Riyadh on November 4, 2008,
to reportedly ask for Saudi support for Plan B and up to $6 billion in deferred payments
for petroleum imports.16 The deferred oil payments would free up capital that Pakistan
could then use to pay its other international obligations. In an interview prior to his
9 Mubarek Zeb Khan, “$4.5 Billion Needed within 30 Days to Build Up Reserves: Recourse to
IMF Last Option,” Dawn, October 23, 2008.
10 “ADB Provides Pakistan with $500 Million to Accelerate Economic Transformation,” ADB
press release, September 30, 2008.
11 “WB to Give Pakistan $1.4 Billion This Year,” Daily Times, October 13, 2008.
12 Nissar Hoath, “UAE to Host Pakistan Bailout Talks Next Month,” Emirates Business 24/7,
October 27, 2008.
13 “President Zardari, Chinese Premier Hold Formal Talks; China Vows to Bail Out Pakistan,”
Daily Times, October 17, 2008.
14 “China Agrees to Give $500m in Bailout,” The Daily Mail, November 14, 2008.
15 Ibid.
16 Baqir Sajjad Syed, “Zardari’s Saudi Visit Part of Attempt to Avoid IMF Loan,” Dawn,
November 4, 2008.

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departure, Tarin stated, “We will not require IMF support in case we succeed in getting
money from Saudi Arabia.”17 Saudi relations with Pakistan, however, have been cool
lately for several reasons, including Pakistan’s quest for an oil facility in Iran. There was
not public announcement of support at the end of President Zardari’s Saudi Arabia trip.
Plan C: IMF Assistance. With the apparent failure of both Plans A and B,
Pakistan moved on to Plan C — formally requesting IMF assistance. On October 22,
2008, the IMF released a statement announcing that “The Pakistani authorities have
requested discussions with the IMF on an economic program supported by financial
assistance from the Fund to meet the balance of payments difficulties the country is
experiencing....”18 The Pakistani government, however, has denied making a formal
request to the IMF.19 According to various reports, informal talks between Pakistan and
the IMF have been going on for some time in Dubai.20
According to China’s Xinhua News Service, the IMF has proposed 16 conditions on
providing assistance.21 Various news accounts have divulged some of those conditions:
a devaluation of the rupee; a reduction of the federal deficit from the current 7.4% of GDP
to 4.3% of GDP by June 30, 2009; an increase in the base interest rate (currently 13%) by
350-400 basis points; a 30% cut in defense spending between 2009 and 2020; the
elimination of nearly two-thirds of pensionable government jobs; tax reform designed to
broaden the tax base, including new taxes of certain agricultural crops; direct IMF and
World Bank monitoring of the preparation of Pakistan’s federal budget; and prior
notification of any funding agreement with any other lender.22
Pakistan has repeatedly stated that it sees formally asking for IMF assistance as a last
resort. The Pakistani government is reluctant to accept formal IMF assistance for several
reasons. First, there is a history of poor relations between Pakistan and the IMF.
Relations between the Pakistani government and the IMF may have been further strained
by recent reports that the IMF applied pressure on the World Bank to cancel $300 million
in aid to Pakistan. Second, the proposed reduction in defense spending will be unpopular
with the military and may make it more difficult for the government to combat Islamist
militancy. Third, the proposed tax reforms, especially on agricultural crops, might lead
to higher food prices and more inflation. Similarly, the elimination of government jobs
17 Sahar Ahmed, “Pakistan’s Zardari to Seek Help in Saudi Arabia,” Reuters, November 4, 2008.
18 “Statement by IFM Managing Director Strauss-Kahn on Pakistan,” IMF press release No.
08/254, October 22, 2008.
19 “IMF Bailout: The Coming Medicine for Pakistan?” Reuters, October 27, 2008, and Sahar
Ahmed, “Pakistan’s Zardari to Seek Help in Saudi Arabia,” Reuters, November 4, 2008.
20 The meetings were held in Dubai, and not Islamabad, because of an IMF ban on travel to
Pakistan. An IMF mission was in Islamabad on September 20, 2008 — the day of the suicide
bombing of the Marriott Hotel. The IMF mission was unable to complete its project.
21 “Pakistan Accepts IMF Conditions For Financial Aid,” Xinhua, November 3, 2008.
22 “IMF Bailout: The Coming Medicine for Pakistan?” Reuters, October 27, 2008; and “Bitter
Fruits of IMF Bailout,” The International News, October 24, 2008; “Pakistan, IMF Agree to Cut
Down Expenditures,” The International News, November 1, 2008; “Pakistan Accepts IMF
Conditions For Financial Aid,” Xinhua, November 3, 2008; and Sahar Ahmed, “Pakistan’s
Zardari to Seek Help in Saudi Arabia,” Reuters, November 4, 2008

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would exacerbate Pakistan’s already serious unemployment problem. Fourth, the higher
interest rates might drive some companies out of business. In the words of one Pakistani
economist, “Given our current political scenario, the standard IMF program would be
disastrous.”23
On November 15, Tarin announced that Pakistan had reached a tentative agreement
with the IMF to borrow $7.6 billion over the next 23 months.24 The first installment of the
loan — up to $4 billion — was expected by the end of November; Pakistan is to repay the
loan by 2016.25 According to Tarin, the only condition set by the IMF was that Pakistan
had to raise its interest rates to counteract its inflation problem. President Zardari
reportedly commented on the IMF loan, “I think it’s a difficult pill, but one has to take
medicine to get better.”26 News of the IMF loan agreement was quickly met with strongly
worded opposition inside Pakistan. Several members of Pakistan’s parliament stated that
the loan would lead Pakistan into a debt trap, worsen the national economy, and harm the
living standards of the Pakistani people.27
If Pakistan’s agreement with the IMF is formally concluded, the $7.6 billion loan is
well short of the estimated $10 billion to $15 billion Pakistan says it needs over the next
two years to avoid a financial crisis. Some observers speculate that the IMF agreement
will spur help from other potential donors, such as China, Saudi Arabia, and the United
States.
Pakistan’s Long-Term Economic Problems
Assuming Pakistan is able to secure the capital assistance it needs, it will not end the
nation’s economic problems. Pakistan’s recent period of economic growth was based on
a combination of export expansion and inward foreign direct investments (FDI). Pakistan
was able to finance its modest trade and capital account deficits in part due to the inward
FDI and in part due to remittances from overseas Pakistanis.
In 2007 and 2008, a rise in fuel and food prices, combined with political instability,
led to a rapid rise in inflation, a spike in the trade and current account deficits, a
devaluation of the Pakistani rupee, and a sharp decline in inward FDI. Foreign investment
in Pakistan during its fiscal year 2007-2008 (July-June) was down by 38.4% from the
previous year. Although global fuel and food prices are on the decline, the global financial
crisis is expected to precipitate a possibly extended global recession. For Pakistan, a
global recession will reduce demand for its exports and inward FDI flows.
23 S. M. Naseem, “For Economic Recovery in Pakistan,” Overseas Pakistani Friends
[http://www.opfblog.com], September 25, 2008.
24 “IMF Okays $7.6 Bln Package for Pakistan: Tareen,” Associated Press of Pakistan, November
15, 2008.
25 Jamie Anderson, “Pakistan Turns to IMF for Financial Aid,” Money Times, November 16,
2008.
26 “IMF Bails Out Pakistan with $7.6 Billion Loan,” Domain-B, November 17, 2008.
27 “Several Senators Oppose Recourse to IMF Facility,” Associated Press of Pakistan, November
13, 2008.

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The combination of high rates of inflation and high unemployment apparently have
contributed to a rise in poverty and hunger in Pakistan. According to one estimate,
Pakistan’s unemployment rate in urban areas is nearly 40% and in rural areas over 60%.28
A recent United Nations study reportedly determined 10 million Pakistanis are
undernourished and over half of Pakistan’s population can be considered “food
insecure.”29 Some observers speculate that the recent growth in poverty and hunger is
exacerbating Pakistan’s political problems.
When he announced the previously mentioned economic policies in September 2008,
Finance Minister Qamar said that the economic stabilization package would create jobs,
promote agriculture and manufacturing, and reduce poverty. There is concern in Pakistan,
however, that the required higher interest rates will force smaller businesses into
bankruptcy and the repayment of the IMF loan will stunt future economic growth.
Implications for U.S. Relations
As previously mentioned, the U.S. government considers a stable Pakistani
government important for several reasons. In addition, because Pakistan possesses nuclear
weapons, an unstable government poses a threat throughout South Asia. As a result,
Pakistan’s current capital crisis and its underlying economic problems may pose a serious
threat to U.S. regional and global interests.
Several recent events and trends, however, may have harmed U.S. relations with
Pakistan. Although the United States provides both military and humanitarian assistance
($968 million in FY2008), Pakistan is increasingly turning to other friendly nations —
such as China and Saudi Arabia — for support. Pakistan’s trade relations have shifted so
that China is its largest trading partner, followed by Saudi Arabia.30 In addition, U.S.
military incursions into Pakistani territory and the signing of nuclear cooperation
agreement with India31 have harmed U.S.-Pakistan relations. Also, some Pakistani
analysts thought the United States was orchestrating the negotiations with the IMF and
the Friends of Pakistan to force Pakistan to accept the tougher IMF conditions.
Some analysts maintain that there is a need for the United States to demonstrate its
commitment to a stable and democratic Pakistan with an increase in non-military
assistance.32 In their view, with the IMF loan settled, there is an opportunity for the United
States to demonstrate its support for Pakistan by providing a portion of the missing $2
billion to $7 billion in assistance. Others think that the United States should condition
additional aid on Pakistan increasing its commitment to combat Islamist militancy along
its border with Afghanistan.
28 Hashim Abro, “Inflation, Unemployment and Recruitment,” Pakistan News, October 27, 2008.
29 Nick Schifrin, “Pakistan Headed for Economic Meltdown?,” ABC News, October 21, 2008.
30 Global Trade Atlas data.
31 For more information on the agreement, see CRS Report RL33016, U.S. Nuclear Cooperation
with India: Issues for Congress, by Paul K. Kerr.
32 Craig Cohen and Derek Chollet, “When $10 Billion Is Not Enough: Rethinking U.S. Strategy
toward Pakistan,” Washington Quarterly, Spring 2007, 30:2, pp. 7-19.

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