Pakistan’s economic trajectory is increasingly shaped by its complex foreign policy, particularly its relationships with the United States and China. As a country striving to achieve economic stability, Pakistan finds itself in a precarious position, balancing diplomatic and economic ties between two global superpowers while simultaneously grappling with an alarming debt crisis and stringent conditions imposed by international lenders. The nation’s economic outlook depends largely on how it navigates these challenges in the coming years.
According to the official figures, Pakistan’s economy has shown some signs of recovery in the first half of the 2025 fiscal year, yet structural weaknesses persist. The economy expanded by 2.5% in FY2024, recovering from a previous contraction, but this remains insufficient to meet the needs of a rapidly growing population. Inflation dropped significantly to 7.2% in H1-FY2025 from 28.8% in the previous year, offering temporary relief to consumers. Investor confidence has marginally improved, with FDI increasing by 20% during H1-FY2025. A record $35 billion in remittances bolstered foreign exchange reserves, offering some stability to the country’s financial system. Despite these improvements, Pakistan remains financially vulnerable due to its growing external debt, inconsistent fiscal policies, and reliance on external aid.
IMF’s dislike for Chinese debt has been made obvious by its restriction on Pakistan for paying Chinese loans.
Pakistan’s foreign relations have long been dominated by its strategic positioning between the US and China. While both countries play crucial roles in Pakistan’s economy, their growing rivalry has placed Pakistan in a difficult position. The country is faced with a choice, US and China: Economic Allies or Adversaries.
China: The Economic Lifeline or a Debt Trap?
China has emerged as Pakistan’s largest investor and lender through the China-Pakistan Economic Corridor (CPEC), a key component of the Belt and Road Initiative (BRI). CPEC has led to massive infrastructure developments, including highways, energy projects, and industrial zones. However, this partnership comes at a cost. By March 2020, Pakistan’s debt to China had grown by 185%, reaching $11.8 billion of its $72.7 billion external debt. Overdependence on Chinese-built power plants has led to overcapacity and high electricity costs, exacerbating financial strains on Pakistan’s struggling energy sector. With a debt of over $29 billion, Pakistan’s repayment obligations to Chinese financial institutions remain a growing concern, as servicing these debts limits fiscal space for other development needs.
The US: A Waning Partnership but a Key Export Market
The United States, historically one of Pakistan’s major allies, has significantly reduced its economic assistance in recent years. However, it remains Pakistan’s largest export destination and a key player in its technology and education sectors. The decline in US aid has weakened Pakistan’s military and economic reliance on Washington. But is this an opportunity or a blessing in disguise?
However, trade relations remain strong, with Pakistani textile and IT exports benefiting from US markets. The shift in US foreign policy, favouring India as a regional ally, has diminished Pakistan’s diplomatic leverage.
While Chinese investment has fuelled infrastructure growth, it has also added to Pakistan’s debt burden. Simultaneously, Pakistan’s engagement with the International Monetary Fund (IMF) has imposed stringent economic conditions. The IMF approved a 37-month, $7 billion bailout package to help Pakistan stabilize its economy, but with conditions including tax reforms and reduced government subsidies. Pakistan faces nearly $90 billion in debt repayments over the next three years, a significant portion owed to China. The IMF’s structural reforms, while essential for economic discipline, have also led to short-term hardships, including increased taxation and reduced public spending. However, IMF’s dislike for Chinese debt has been made obvious by its restriction on Pakistan for paying Chinese loans.
Foreign Policy Alignment: The Way Forward
Navigating the US-China rivalry requires diplomatic finesse to avoid alienating either power, which could impact economic and security assistance. Given its economic vulnerabilities and geopolitical tensions, Pakistan must adopt a pragmatic and balanced foreign policy to secure sustainable growth. Diversify Economic Partnerships: Reducing over-reliance on China and the US by strengthening trade and investment ties with the European Union, the Gulf states, and ASEAN countries can provide economic resilience.
Strengthen Domestic Resource Mobilization: Improving tax collection and broadening the tax base can reduce dependency on external loans and aid. However, the need to satisfy IMF conditions while maintaining sovereign economic policies can lead to domestic discontent and policy inconsistencies.
Enhance Transparency in Foreign Deals: Ensuring parliamentary oversight and transparency in foreign investments can prevent unfavourable debt arrangements. Invest in Human Capital: A focus on education, research, and skill development can create a self-sustaining economy that attracts global investments beyond traditional sectors.
Pursue Balanced Diplomacy: Pakistan must navigate its relations with both China and the US carefully, leveraging economic opportunities from both while avoiding entanglement in their strategic rivalry.
The nation’s ability to strike a balance between Chinese investments, US trade relations, and IMF-driven economic reforms will determine its financial future. By pursuing a more diversified and self-reliant economic strategy, coupled with a pragmatic diplomatic approach, Pakistan can mitigate its vulnerabilities and pave the way for long-term stability and growth.
The writer is Foreign Research Associate, Centre of Excellence, China Pakistan Economic Corridor, Islamabad.