Can Pakistan Stay Afloat?

This time it wasn't the terrorist scare making Pakistanis nervous. Depositors thronged banks over the last few days to retrieve cash and valuables. Rumors that the government was on the verge of seizing bank lockers and foreign-currency accounts to rescue its deteriorating financial positions had been popping up on cell phones. They were finally laid to rest on Wednesday by Pakistan's newly appointed finance minister, Shaukat Tareen. A well-respected former banker who is not a member of Parliament, he is the third person to head the ministry since government formation in March, and his appointment is intended to signal President Asif Ali Zardari and his government's seriousness about setting the economy straight.

The Zardari government is sailing into a perfect storm of political instability and economic turmoil. The economy is in a virtual freefall. International agencies have slashed its credit ratings. The rupee has hit an all-time low against the dollar. Capital flight is believed to be continuing despite efforts to stop it. Suicide attacks and kidnappings have led to the repatriation of foreign skilled labor. The bourses are a blood bath as foreign investors continue to pull out. Unable to pay its bills, the government has taken to issuing I.O.U.s to private- and public-sector companies. Overall inflation is at a punishing 30-year high. Power shortages, the worst in at least 15 years, are disrupting businesses already hurt by higher input costs. To top it off, much-needed funding and easier terms promised by Pakistan's allies and multilateral donor agencies have yet to materialize. Foreign-exchange reserves, worth about two months of imports, are fast running out—and with the worsening economic situation, so is public patience.

For its part, the Zardari-led coalition government, already besieged by political rivals and insurgent groups, has had to take unpopular measures to prop up the economy. It has raised taxes, upsetting the business community. It has trimmed government spending, prompting bureaucrats to grumble. It has increased tariffs on power, angering consumers and businesses already fed up with outages. And it has phased out subsidies on imported fuel, leading to price increases in everything from bus rides to cooking oil and prompting small, periodic protests. "Inflation accounts for most of the public disgruntlement," says Mansoor Hussain, a columnist for the English-language Daily Times. "The popular expectation seems to be that the U.S. and world community will not allow Pakistan to fail and will foot our bills for what is still considered by us to be their war," he told NEWSWEEK. But an oil deal with the Saudis is yet to come through, and substantive foreign-currency inflows remain elusive despite public commitments by allies, including the United States, which is facing its own economic crisis. Hoping to attract capital from various sheikhdoms, the government is dusting off a privatization program that has been stalled since the then chief justice overturned a steel-mills deal leading to his ouster.

For some, it is difficult to believe that this is the same economy that grew at a clip of at least 6 percent annually (including during the past tumultuous year) under former President Pervez Musharraf. "The economic situation had been depressed in the 1990s, and a lot of catch-up took place under Musharraf, leading to eye-popping growth," says Ehsun Khan of BMA Capital in Karachi. "Pakistan's growth has not been based on industrial or exports growth, it's been based on consumer spending fueled by bank lending." Whereas the previous government was able to finance its current account deficit through privatization proceeds, bonds issues, and foreign direct investment, these channels have dried up with Pakistan's security woes and the global credit crisis. "Consumer spending has been hit by the global oil shock, which no one saw coming, as well as liquidity issues in the market on account of government borrowing and stringent regulatory conditions," he said.

Standard & Poor's earlier this month downgraded Pakistan's credit rating for the second time this year. According to S&P, Pakistan's foreign-exchange reserves have fallen by 67 percent in the past year to $4.7 billion and it anticipates difficulties for the country in repaying $3 billion in debt-servicing costs. Capital inflows that had enabled Pakistan to fulfill its financial obligations have become "deterred by prolonged political uncertainty and an adverse security climate," according to S&P. Last month, credit rating agency Moody's Investors Services downgraded Pakistan's bond rating from stable to negative citing "substantial erosion in the country's external liquidity position," which was "not likely to be adequately reversed by external assistance or ongoing efforts at macroeconomic stability."

Even as the strain on Pakistan's economy from suicide bombings and political wrangling becomes manifest, the opposition seems intent on sitting out the war against terrorism and not making Zardari's or his government's jobs any easier. On Thursday, after the second day of a rare in-camera intelligence briefing on the militancy to Parliament concluded, opposition members, particularly those from former Prime Minister Nawaz Sharif's party, expressed dissatisfaction with the proceedings and criticized the government for "continuing" with Musharraf's policies. Other right-wing politicians, including Qazi Hussain Ahmed of the Jamaat-e-Islami and former cricket star Imran Khan, who are not members of Parliament but were invited by Zardari to attend the sessions, refused to participate. The same day, a suicide bomber breached Islamabad's high-security zone and blew up a police station. Hours later, the government said it had foiled another attack, this time at the Benazir Bhutto International Airport, and arrested a would-be suicide bomber. Many are hopeful that a political consensus will emerge with the stakes rising for all politicians. Asfandyar Wali Khan, who leads the secular Pashtun party allied with Zardari, was attacked at his home. Days later, a member of Parliament from Sharif's party was attacked at his home. Both survived the attacks, which together left at least 24 dead.

Pakistan's resolve against terrorism will be severely tested if the economy continues to weaken. The government, which is seeking $100 billion in aid and soft loans for the next five years, has organized the Friends of Pakistan forum and received commitments from several quarters, including the U.S. Congress, that will bring in capital easing pressure on both the government and the public. Many hope that Zardari, who has proved to be a savvy dealmaker, will be able turn things around. But, as the S&P notes in its report, "multilateral and bilateral aid, including deferred oil-payment schemes, may not be timely enough."