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October 13, 2017



Will history repeat itself?

The economy is in hot water. Trade and current account deficits, which have gone up at a gallop over the past 15 months, have squeezed the foreign exchange reserves. This has reduced our ability to pay for imports and service external debt.

Amid the shafts of uncertainty running through politics and with the election cycle only a few months away, it seems more a question of when Pakistan will choose to go back to the IMF than of whether it will knock at the door of the multilateral donor.

First, the facts. The financial year 2016-17 (FY 2017) saw the current account deficit rise to $12.1 billion from $4.6 billion a year earlier. The trade deficit, the major item on the current account, scaled up to $26.8 billion from $19.28 billion in FY 2016. Exports marginally came down to $21.6 billion from $21.9 billion. Imports went up to $48.5 billion from $41.2 billion a year earlier. Remittances, which have anchored the economy over the years, went down slightly to $19.3 billion from $19.9 billion a year earlier (as per the SBP’s data).

The first two months of the current financial year (FY 2018), do not present an encouraging picture either. The current account deficit stands at $2.6 billion – as compared with $1.2 billion during the corresponding period of FY 2017 – and the trade deficit of $5 billion – as compared with the last year’s $3.6 billion.

Exports have shown a better performance ($3.9 billion as compared with $3.3 billion). However, imports continue to rise ($8.9 billion as compared with $7 billion). If the present trend persists, FY 2018 may close with larger current and trade account imbalances than in the preceding year. At the end of September 2017, the foreign exchange reserves held by the SBP have come down to $13.85 billion from $16.14 billion at the end of FY 2017 and $18.49 billion a year earlier.

During the past nine years, Pakistan has approached the IMF twice to pump funds into the cash-strapped economy. Each occasion came soon after a new government took office. In October 2008, a precarious economic situation forced the PPP government to sign a Stand-by Arrangement (SBA) with the IMF. Trade and current account deficits had ratcheted up to $21 billion and $14 billion respectively, foreign exchange reserves had depleted to $7.31 billion (as on October 17, 2008) while the exchange rate had nose-dived to Rs 82.37 per dollar from Rs 60 a few months ago.

The SBA provided for a loan worth $7.6 billion, which was later enhanced to $11.3 billion. However, the agreement came to a premature end in September 2011 as the government was unable to take the agreed reforms. As a result, only $7.27 billion were disbursed.

In September 2013, another agreement with the IMF was struck to provide assistance worth $6.12 billion over three years under the donor’s Extended Fund Facility (EFF). The EFF has a longer repayment period (between four-and-a-half and 10 years) than the SBA – for which the maximum period is five years.

The agreement was concluded by the nascent PML-N government notwithstanding the ruling party’s pre-poll pledges to break the begging bowl once and for all. Again, a difficult balance of payment situation (a trade deficit amounting to $15.4 billion trade deficit, a current account deficit worth $2.5 billion and meagre foreign exchange reserves of $6 billion at the end of FY 2013) made the government return to the multilateral donor. The credit agreement was a classic case of borrowing afresh to work off the existing debt.

For a sovereignty-obsessed nation, foreign credit – particularly from the IMF – is a bitter pill to swallow. But whether we like it or lump it, it does at times becomes difficult for the government to keep its head above water. A country’s request for IMF credit signifies two things: that the economy is in a critical condition and needs an immediate injection of capital and that – given the political and economic costs of the IMF’s assistance – cash inflows from other potential sources are not coming through. Because the IMF’s conditionality is perceived to be tougher and politically unpleasant, its assistance is usually sought as the last resort.

An IMF-sponsored programme is a bailout and not a development package. The purpose is to help the country service its debt, make payment for imports and build its foreign exchange reserves. In the past, assistance from the IMF did save the country from having to default on debt repayment and made it possible to pay for imports. The reserves build-up from the IMF’s assistance and the subsequent capital inflows from other donors improved Pakistan’s credit rating, conveyed a positive signal to the domestic foreign exchange market and brought a measure of stability to the exchange rate.

Be that as it may, such credit arrangements can contribute little to reducing the trade deficit, which is the capital source of the balance of payment problem. It may be argued that the depreciation of the rupee – a typical IMF recipe – may make exports cheaper and imports expensive and thereby help narrow trade deficit. However, the relationship between depreciation/devaluation and the trade balance is not that simple.

The effect of depreciation on the trade balance is contingent on several factors. For a country like Pakistan, which depends on the import of capital equipment and raw materials for its exports, the increase in import prices may drive up the cost of production of exportable goods. This will adversely affect their competitiveness. Hence, the effect of the depreciation on exports can go either way. As for the effects on imports, nearly two-thirds of our imports consist of petroleum products, capital equipment, raw materials and food products for which the demand tends to be largely inelastic.

The trade deficit, along with the fiscal deficit, has been a perennial feature of our economy – as in the case of most other net petroleum-importing developing countries. The reasons for this are both economic and cultural in nature. These economies need to import a great deal of capital equipment and industrial raw materials to maintain or accelerate the growth momentum. The people who live in such societies are strongly inclined towards imitating the lifestyle that is in vogue in rich countries even though they lack the corresponding productive capacity, which encourages the import of luxury goods. Owing to the severe supply-side constraints, coupled with a relatively large population, exports can’t keep pace with imports.

Obstacles to export promotion fall into three categories: market access, the high cost of doing business and structural constraints. The focus of the government as well as the private sector has been on overcoming the first and second obstacles. Lowering the cost of doing business and securing preferential access into foreign markets is important. But without addressing the structural constraints, an appreciable increase in exports is not possible. Unfortunately, the latter has been short-shrifted by both the government and the businesses.

Going back to the IMF will cast a pall over the government’s economic performance. As a result, it will endeavour to the hilt to ride out the tough economic situation and leave the crucial decision to its successor. That’s what the PPP government did in 2013.

At any rate, no ruling party wants to open and close its innings by signing a multi-billion dollar credit deal with the same donor. So it’s likely that this decision will be put off till the elections. One option may be to let the caretaker government negotiate and strike an agreement with the IMF. In the past, the caretaker governments have signed credit deals with the multilateral donor twice – in 1988 and 1993. It may be a sheer coincidence that on each occasion the deal was inked just before Benazir Bhutto was sworn in as prime minister. Who says history doesn’t repeat itself?

The writer is a freelance countributor.

Email: [email protected]