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Economic notes

September 18, 2017

Can we avoid the IMF?


September 18, 2017

In a recent interview, Prime Minister Abbasi remarked that he did not see the need for an IMF programme in the near future. This is the yearning of every Pakistani, as they have seen more than their due share of Fund programmes. However, the direction and pace of economic winds point to a gathering storm, threatening the serenity and tranquillity of the progress made in the last three years.

During 2013-16, Pakistan’s economy showed unprecedented improvement. Earlier, stagnant and low growth, rising inflation, high fiscal deficit, falling revenues, rising circular debt in the energy sector, declining reserves, unstable exchange rate and declining private sector investments were the highlights of the economy.

A home-grown economic reforms agenda was implemented under a three-year IMF programme and the turnaround was impressive. Growth was revived, inflation was historically low, deficit was down to nearly 4 percent from 8.2 percent, revenues grew by a cumulative 60 percent, reserves increased to a historic high of $24.5 billion in October 2016 and the exchange rate was stable.

Then in 2016-17, there was an unravelling of the gains, primarily due to an unprecedented surge in fiscal and current account deficits, leading to loss of reserves. What contributed to this development:

Fiscal deficit: The Fund programme aimed to reduce fiscal deficit from 8.2 percent to 3.5 percent in three years. In 2015-16 (third year) we achieved 4.3 percent against the target of 3.8 percent (including 0.3 percent one-off for security). The target for 2016-17 was 3.8 percent but final deficit was 5.8 percent. Both revenues and expenditures were off the mark.

A tax shortfall of Rs259 billion and a shortfall of Rs100 billion in gas cess were the main reasons on the revenue side. The expenditures were higher by Rs478 billion, showing explosive growth in spending. The provinces exhausted much of the surplus they had generated to enable the country to meet fiscal adjustment targets. Against a budgeted surplus of Rs300 billion, the provinces incurred deficit of Rs162 billion.

Had it not been for a clever use of selling security press to the SBP and invest-in and sell the LNG-based power projects (and other one-off adjustments), which yielded revenues of more than Rs300 billion, fiscal deficit would have shot-up to 7 percent. Despite this, the country is nearly back to where it stood in June 2013. Making appropriate adjustment for circular debt would take the deficit where it stood in 2013.

However, there is one major difference: we have an expanding and booming economy. We failed to exercise due care in economic management otherwise the opportunities reflected in spectacular growth in spending and imports would have meant a boon for the economy. It may still be so, if our house is put in order.

Current account deficit: The marked increase in fiscal deficit has translated into an explosive growth in the current account deficit (1.7 percent to 4.0 percent of GDP). On FOB basis, imports increased by 18 percent while exports were marginally down by 1.4 percent. Deficit in services account increased by 7 percent. Primary Income (interest and profit) showed a slight improvement of 11 percent. Secondary income deficit was nearly the same.

Thus, the marginal increase of $7.3 billion, or nearly 2.5 percent of GDP, emanated from increased imports. The bulk of the increased imports were capital goods (37 percent) and petroleum products (30 percent), constituting 43 percent of imports. The quantity effect was 72 percent and price effect was negative 28 percent reflecting more quantities at lesser unit values, supporting an expanding economy.

Since increased imports are productive, why worry?

Loss of reserves: It is the loss of reserves, for the first time under this government. Though during the year, we lost about $2 billion, it is about $5 billion from the peak of $24.5 billion last October. We failed to secure financing to fund the deficit.

In the capital account, there was only a marginal positive increase of $100 million. In the financial account, there was a net increase of $2.8 billion (despite a net inflow of $3.9 billion ($8.9b-$5.0b)). Consequently, reserves fell by $1.9 billion compared to a gain of 2.7 billion last year, implying a deterioration of BOP position by $4.6 billion.

Why loss of reserves?: Three reasons: (a) Inability to access loans beyond the level contracted during the year, net of repayments; (b) Excessive demand for imports in the public sector due to import of capital goods (LNG-based power projects), increase in imported energy (LNG and Coal), and increased security spending with falling CSF receipts; and, (c) Steep increase in public spending (surge in deficit), a significant part of which translated into higher import demand using precious reserves.

Exchange rate stability: The loss of reserves of nearly $4.6 billion in a year is effectively the cost of maintaining a stable exchange rate. The draw-down of reserves meant, in a highly competitive and transparent forex market, that whenever there was pressure on the exchange rate, the SBP stepped forward to supply the dollars, even if it meant losing reserves.

The country had painfully built these reserves on the back of privatisation proceeds, CSF receipts, auction of spectrum licenses, loans from IMF, World Bank and ADB, issue of Bonds and Sukuk and from the commercial banks. It is sad to note that precious resources are used to support the exchange rate, something IFIs or investors would not approve of.

Despite positive trends in leading indicators in Jul-Aug, the fundamental imbalances noted above are persisting. If they continue, it is not a matter of ‘whether’ but ‘when’ the country will go to the Fund. Given the security outlook facing the country, this is not a happy contingency. To avert this possibility, the prime minister, having taken the reins of economic management, should restore fiscal discipline and allow market forces to determine the exchange rate.


The writer is a former finance secretary. Email: [email protected]



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