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Economic notes

March 13, 2018

Where the economy stands


March 13, 2018

Taking a break from our series on ‘Economic Reforms’, let’s review some major economic developments affecting our economy. Of particular interest is what the IMF recently said about the state of economy in a report submitted to its executive board, after the conclusion of the IMF’s first post-programme monitoring (PPM) discussions on March 5, 2018.

In a curious development, the government has not yet allowed the publication of the full PPM report, which is normally done soon after it is presented to the Fund’s board. This has never happened before. There were, in the past, standing instructions to simultaneously place such reports on the website of the Ministry of Finance. We hope better sense will prevail and the report will be made public.

The IMF’s press release summarising the contents of the PPM report is not complementary. As we have been arguing in these pages, Pakistan’s economy is showing strong signs of rising growth and price stability. Yet the policy actions of the government are, rather than helping the process, creating vulnerabilities. The press release acknowledges 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”.

The statement then goes on to caution that the “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. 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.”

Before reflecting on the above paragraph, let us note that the Fund has given a conservative assessment of the economic buoyancy, while softening its views on rising vulnerabilities. The target of 6.0 percent growth for the year is still possible, despite its recent revision by the SBP to 5.8 percent. On the other hand, fiscal deficit, based on financing side, looks set to follow the trend set last year, while the external account deficit is likely to be at least five percent. But the said paragraph is the disturbing part of the press release. This is an unprecedented expression of concern. What it says is that the risks to Pakistan’s capacity to repay the Fund have increased.

It is important to understand the circumstances that led to such an assessment. The text also points out that this risk developed “against the background of rising external and fiscal financing needs and declining reserves”. This characterisation of the background is a classical definition of macroeconomic instability. In an unstable state the terminal date is guaranteed, unless a major reform effort is undertaken to reverse the course of events heading in that direction. This terminal date is determined by the distance one can travel while continuing to deplete the available foreign exchange reserves.

Since 1988, when the country entered into its first structural adjustment programme with the IMF, it has followed an identical pattern to reach this state. Extraordinary demand is created by the country incurring a large fiscal deficit, which turns into a large (mirror-image) balance of payments (BOP) deficit, and then we run out of reserves to finance the BOP deficit. In Jan-Feb 2018, we have lost nearly $2 billion and also borrowed at least $500 million. At this rate of depletion, the terminal date is not far off.

More accurately, since the end of September 2016, when the public external debt outstanding was merely $57 billion, till the end of December 2017 (15 months) – when it stood at about $67 billion – the external debt outstanding increased by $10 billion. During the same period, SBP reserves declined by $6.3 billion. This gives a staggering figure of $16.3 billion that the country used up in supporting the balance of payments and maintaining the so-called exchange rate stability. There is no previous example of such a large amount being used to support the exchange rate, but the possibility of acquiring additional resources from the market are diminishing. Also, the debt accumulated during this period will soon pose a major repayment burden. In fact, we may already be late in raising a red-flag and seeking outside help.

An equally distressful situation is visible on the side of domestic borrowings, where the central bank is lending to the government without hesitation, even at the cost of deleveraging the lending of the banks. As on March 2, the SBP lent nearly Rs1 trillion and the banks divested Rs400 billion from government securities. Since last August, all PIB auctions have gone unsubscribed; whereas investment among the T-Bills is made only in three-month securities. In the last auction of T-Bills, held on February 28, against a target of Rs650 billion, bids for only Rs284 billion were accepted for a three-month maturity. For several months now, no T-Bills for six months or 12 months have been subscribed. This will be the second consecutive year when the SBP will be the primary source of financing fiscal deficit (via currency printing).

Evidently, major imbalances have developed in key economic variables – fiscal deficit, BOP deficit, exchange rate, policy rate and monetisation of deficit. These would require equally major adjustments whenever the country decides to put its house in order.

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

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