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March 8, 2018

Rising deficits, forex reserves decline risk to economic stability: IMF

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March 8, 2018

ISLAMABAD: The International Monetary Fund (IMF) has warned Pakistan about ‘continued erosion of macroeconomic stability’ with the risks of rising twin deficits -- the budget deficit and current account deficit simultaneously at a time of depleting foreign currency reserves.

Against the background of rising external and fiscal financing needs and declining reserves, the IMF has conveyed in plain words that risks to Pakistan’s medium-term capacity to repay the Fund debt have increased since completion of the last Extended Fund Facility (EFF) arrangement in September 2016.

The IMF also raised its concern over the China Pakistan Economic Corridor (CPEC) for expanding external sector pressures and stated that the Fund directors noted that the external sector pressures are in part linked to the fiscal deterioration during the last fiscal year and an accommodative monetary policy stance, as well as the high imports related to the CPEC.

The Fund projected fiscal deficit at 5.3 percent of GDP and current account deficit at 4.8 percent of GDP equivalent to $16.6 billion for the current fiscal year. The CAD has already gone up to $9.2 billion for first seven months of the current fiscal year. The IMF has projected that the gross foreign reserves will nosedive to $12.09 billion in the current fiscal against $16.141 billion, indicating that over $4 billion reserves were expected to be depleted in the ongoing financial year.

The IMF’s Executive Board concluded the first Post-Programme Monitoring Discussions with Pakistan on March 5 in Washington, DC, but took more than one and half days for issuing its formal statement. The IMF highlighted the increasing burden of debt and asked the authorities for taking corrective measures.

In order to tackle concerns on account of external front, the IMF suggested further exchange rate flexibility, indicating that the multilateral creditors were proposing more depreciation of Pak rupee against dollar and other currencies.

The IMF says that Pakistan’s near-term outlook for economic growth is broadly favourable. Real GDP is expected to grow by 5.6 percent in FY 2017/18, supported by improved power supply, investment related to the China Pakistan Economic Corridor (CPEC), strong consumption growth, and ongoing recovery in agriculture. Inflation has remained contained.

However, the Fund warns that continued erosion of macroeconomic resilience could put this outlook at risk. Following significant fiscal slippages last year, the fiscal deficit is expected at 5.5 percent of GDP this year, with risks towards a higher deficit ahead of upcoming general elections, the IMF predicts as provinces might opt to go for rampant spending breaching the IMF projection by end of the day.

Dwelling upon second risk, the IMF says that surging imports have led to a widening current account deficit and a significant decline in international reserves despite higher external financing. The FY 2017/18 current account deficit could reach 4.8 percent of GDP, with gross international reserves further declining in a context of limited exchange rate flexibility. Against the background of rising external and fiscal financing needs and declining reserves, risks to Pakistan’s medium-term capacity to repay the Fund have increased since completion of the Extended Fund Facility (EFF) arrangement in September 2016.

Executive Board Assessment: The IMF’s directors took note of Pakistan’s favourable growth momentum, but noted with concern the weakening of the macroeconomic situation, including a widening of external and fiscal imbalances, a decline in foreign exchange reserves, and increased risks to Pakistan’s economic and financial outlook and its medium term debt sustainability. In this context, they urged a determined effort by the authorities to refocus near term policies to preserve macroeconomic stability.

Directors welcomed the authorities’ move to allow some exchange rate adjustment last December, but stressed the importance of greater exchange rate flexibility on a more permanent basis to preserve external buffers and improve competitiveness. They also encouraged the authorities to phase out administrative measures aimed at supporting the balance of payments as soon as conditions allow to minimise potential economic distortions.

The directors noted that the external sector pressures are in part linked to the fiscal deterioration during the last fiscal year and an accommodative monetary policy stance, as well as the high imports related to the (CPEC) projects. They called on the authorities to strengthen fiscal discipline through additional revenue measures and efforts to contain current expenditure while protecting pro-poor spending.

Complementing the recent increase in the policy interest rate with further monetary tightening would be important to address inflationary risks and help reverse external imbalances. Directors also emphasised the need for prudent debt management and caution in phasing in new external liabilities and the urgency of tackling rising fiscal risks stemming from continued losses in public sector enterprises.

The IMF directors underscored the importance of accelerating structural reforms to reinforce macroeconomic stability, raise competitiveness, and promote higher and more inclusive growth. They highlighted the need to strengthen the fiscal federalism, monetary and financial policy frameworks; further enhance the AML/CFT (Anti-Money Laundering/Counter Financing of Terrorists) regime; improve the business climate; continue to strengthen governance; achieve cost recovery in the energy sector; and expand social safety nets to protect the most vulnerable, the statement concluded.

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