The confidence game

NOTHING gives them confidence like a pile of dollars in the reserves. Over the decades, I have seen this trend. Whoever is ruling Pakistan lacks confidence in themselves while the foreign exchange reserves are low and large debt-service payments are looming on the horizon. But the situation always turns, like these things do. After a few years of a gruelling, IMF-mandated adjustment, the reserves are rebuilt; import cover and debt service cover both rise, and with them also the confidence of the ruler.

It is happening one more time. The foreign exchange reserves have been rebuilt since July 2023. Both reserve adequacy ratios — import and debt service cover — show notable improvements since their low points between the summer of 2022 and 2023. The reserves were barely able to cover 13 per cent of scheduled maturities in the year ahead and three weeks of imports at the low point of both these ratios in December 2022. From there, they have risen and today can cover almost 70pc of scheduled maturities over the next 12 months and more than three months of imports.

The rulers have gained confidence alongside this development, to the point where they feel they are now in a position to dictate terms to their partners in government and seek a major and far-reaching change in the structure of the federation. It almost seems like they took the critique that they had failed to bring about structural reforms to heart. But in seeking to change the very structure of the state, over the objections of the parties whose support helped usher in their government, they might be acting out of a sense of overconfidence.

The improvement in the reserve adequacy ratios is real, but it is already showing signs of having peaked. Consider just what the last seven months have seen. Reserves rose during this period, but the pace of the rise decelerated. Average 12-month reserve increases remained at a high of $5.7 billion till May, then fell to $3.9bn in June and then to $2.7bn in July. More importantly, the rising reserves procured diminishing adequacy when measured against rising import requirements. Despite a billion-dollar increase in liquid reserves between January and July, import cover barely moved past 3.1 months.

Once the trajectory peaks and the reserve decline kicks in, confidence drains out of the government.

This is usually how it begins. It is not clear yet whether the recent $3bn raised via the Eurobond auction will actually stay in the country or be used to retire bilateral debt, as some of the reporting suggests. If the latter, then it will help raise the debt-service coverage ratio but will place more pressure on import cover.

These are signs that on the present trajectory, the reserve accumulation that began in July 2023 has peaked. Once the incremental reserves procure diminishing increases in the twin coverage ratios, and trade-offs begin appearing between improvements in debt-service coverage and import cover, it can be said that the organic trajectory driving reserve accumulation has hit its built-in limit.

From here on, either the trade-offs will sharpen, leading to a peak in reserves followed by a decline, or the government will find alternative sources to continue the build-up. The alternative sources could be Exim Bank financing of some sort from the US, coupled with a line from the US Treasury, assuming it comes through. It could also be more favourable rollovers of existing bilateral maturities, something we will see by December when the Saudi deposits mature.

But one thing is certain. Once the trajectory peaks and the reserve decline kicks in, confidence drains out of the government. The window in which to do dramatic things closes, the resource envelope shrinks and the government goes into defensive mode. That time may still be a little while away. But given how the reserve metrics are shaping up, it would seem that either the rulers have some large-scale inflows lined up or they have come a little late to the game of rearranging the deckchairs.

The situation is aggravated by high oil prices, brought on by the prolonged stand-off that the war in the Middle East has devolved into. With oil already touching $100, global oil inventories depleted and the Hormuz and Bab Al Mandeb straits both under fire, the outlook for oil prices is anything but sunny. Given high oil prices and the great difficulty they are having in procuring LNG cargoes, the real impact of energy prices is yet to land.

The external sector has improved over the past few years — there is no doubt about that. But three things need to be underlined again and again. First, the improvement is not on the scale needed to support a revival of growth, because the burn rates of the reserves that come with growth rates of 6pc or more in Pakistan mean these reserves will barely last 12 months. Second, the improvement is hitting a plateau and will need a fresh line of inflows to sustain itself in the months ahead. And third, a high-energy-price scenario is rapidly taking shape before us; this might be prolonged, which could aggravate the fragility of the external sector in Pakistan.

This is not the time for adventurism or for opening up unnecessary fronts domestically. Going forward, the government is likely to see a rising arc of pressure spreading across the horizon from multiple directions. At a time like this, it needs its decision-making system at home to be on an even keel. This is a bad time to be an embattled ruler, especially if that is a choice that can be avoided. All rulers in the past 25 years have succumbed to the overconfidence that comes with a healing external sector and rising foreign exchange reserves. It’s almost funny how that works: the confidence game in Pakistan is so closely tied to the quantity of dollars in its treasury. But it’s a good idea not to over-count those dollars just yet.

The writer is a business and economy journalist.

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X: @khurramhusain

Published in Dawn, September 10th, 2026