The Pakistan Tehreek-e-Insaf (PTI) led government is embarking upon implementing all major prior actions agreed with the International Monetary Fund (IMF) before signing Letter of Intent (LoI) on the basis of which the fund’s executive board will consider Pakistan’s request for approving the fresh bailout package of $6 billion.
The State Bank of Pakistan (SBP) has now moved away from managed exchange rate to market based flexible exchange rate after which the rupee witnessed a downslide against dollar both in inter-bank and open markets. The IMF, in its latest assessment during the recently held parleys with Pakistani authorities, said the rupee was overvalued in the range of 4 percent on the basis of Real Effective Exchange Rate (REER). But any further slide would not have any justifications keeping in view the fundamentals of the economy.
Secondly, the Monetary Policy Committee (MPC) has been convened earlier than its actual schedule that resulted into raising many eyebrows. It seems that the SBP is going to implement another prior action on policy rate front. Although, it is a fact that the IMF never gives any target on discount rate front , it asks authorities to convene MPC meeting for taking decision on the basis of available data on economic front. It is expected that the MPC will hike discount rate at least 125 basis point (bps) in order to jack the rate up to 12 percent from existing 10.75 percent. The policy rate might hike up to 200 basis points on the eve of unveiling of monetary policy scheduled to be held today (Monday).
The monetary policy is a tool that is used to suppress demand for achieving stabilisation of economy by hiking policy rate and exchange rate anchor. Here the inflation has come down from 9.4 percent to 8.8 percent for April 2019. On other hand, the core inflation in April 2019 stood at 7 percent, while it was on the same level in the same month of the last year. But the policy rate has gone up by around 450 basis points in last one year that does not have any justification. The rising discount rates will shrink investments in months and years ahead, further choking the growth prospects of Pakistan’s economy.
The real GDP growth has nosedived to 3.29 percent for the outgoing fiscal year where agriculture and manufacturing performed very poorly and it might pave the way for increasing poverty and unemployment in the country.
The gradual adjustment on exchange rate front is underway and rupee crossed 150 against dollar in the open market last week.
The REER is based on 2010 and now the IMF has asked Islamabad to update this model by capturing data of all those countries having trade links with Pakistan.
The exchange rate is one of the most important prices and is determined by underlying economic fundamentals. These fundamentals ensure that it would adjust to its equilibrium value over the long run. Pakistan’s approach to exchange rate management was uneven, reflecting both the realities of a thin foreign exchange market and the overriding desire to avoid unnecessary volatility in the foreign exchange market and avoid fiscal cost of exchange rate adjustment, even when it was needed. This has led to persistent overvaluations contributing to a higher trade deficit. The recent pressure on external front is no exception — a manifestation of misaligned exchange rate.
Against this background, the Ministry of Finance envisaged that the principle idea now is to enshrine an exchange rate policy which enhances competitiveness of Pakistani exports, by avoiding the persistent overvaluation of rupee.
Accordingly, the Pakistani rupee has depreciated significantly since November 2017 and currently it is hovering around over Rs148/dollar in inter-bank market. The dollar has disappeared from the open market indicating that hoarding of dollars continues unabated on the expectations that it would be further depreciated.
The depreciation has moved the exchange rate to a level, which is more reflective of economy’s medium-term needs and market conditions while at the same time minimising disorderly fluctuations.
“Going forward, the near-term goal of this policy is to move towards a flexible regime with a transparent auction-based system with clearly defined rules; and having a safety-net in the form of an allocated intervention budget with internal controls to mitigate unwarranted volatility. This mechanism would help ensure healthy two-way movement in the PKR exchange rate, and would be compatible with the implementation of flexible inflation targeting under the SBP vision 2020”, it stated.
For exchange rate management, the government finalised facilitating implementation of flexible inflation targeting as envisaged in SBP Vision 2020. The exchange rate arrangements and possible limits of government borrowing from SBP were also aligned in line with prioritising price stability as an objective of the monetary policy.
Another key area of IMF program will be making renewed efforts to bring reforms into taxation system of the county as it had miserably failed in the past amid disappointing performance where tax-to-GDP ratio remained stagnant during the last two to three decades. Rather the tax-to-GDP ratio is all set to decline in the outgoing fiscal year ending on June 30, 2019. In the next budget, the government will have to come up with a prescription of abolishing tax exemptions and raising tax rates as well as finding out innovative ways to bring more sectors into tax net in order to meet gigantic task for netting taxes of around Rs 5,200 to Rs 5,300 billion. The FBR collection will be hardly touching Rs4,000 billion during the outgoing fiscal year even with the latest tax amnesty scheme. The FBR is estimating that it may collect Rs4,100 billion till June 30 2019.
The yawning budget deficit that is heading towards touching 7.6 percent of the GDP or in absolute figures to the tune of Rs2.9 trillion, it will force the government under tight scrutiny of the IMF program to make massive fiscal adjustments in the next three years. The path is uneven and no easy solution exists.
The government is finding solutions to replace politicians with technocrats on all key positions but they are aliens and will not bother to burden masses out of proportions because they are not answerable to people of Pakistan.
The sequencing and pace of IMF program is quite critical in months ahead and it requires a balancing approach to reduce the burden for low and middle income groups as price hike had already started squeezing them very negatively.
The writer is a staff member