The IMF: our inevitable recipe

The economy is in a tight spot and the government seems to be at a loss on how to dig it out of this situation on its own. The depreciation of the rupee – twice in three months – after nearly four years of managed exchange rate stability is only a kernel of the tailspin into which the economy has been thrown.

We can see with half an eye that another agreement with the International Monetary Fund (IMF) is the inevitable recipe. For some nations, breaking the begging bowl is nothing more than a pie in the sky.

In the first eight months of Financial Year (FY) 2018, the current account deficit reached $10.82 billion as compared with $7.21 billion during the corresponding period of FY 2017. The FY 2018 (July-February) current account deficit is underpinned by $19.69 billion in the merchandise trade deficit ($15.97 billion in exports and $35.66 billion in imports), and $3.53 billion trade in the services deficit ($3.43 billion in exports and $6.97 billion in imports). The $12.83 billion in remittances eased the pressure on the current account balance.

The IMF’s latest report on the Pakistan economy projects a current account deficit worth $15.7 billion (4.8 percent of GDP) for the entire financial year, which will be $3.3 billion higher than what it was in FY 2017 ($12.4 billion or 4.1 percent of GDP). The Fund forecasts a 10 percent export growth and 10.2 percent import growth for the entire FY 2018. This means that exports will reach $22.46 billion while imports will increase to $58.22 billion, resulting in a trade deficit worth $35.76 billion as compared with a deficit of $32.46 billion recorded during FY 2017.

During FY 2018 (July-February), exports and imports have risen by 11.66 percent and 17.9 percent, respectively, on a year-on-year (YOY) basis. Therefore, if we assume that exports and imports will maintain the same growth momentum for the entire FY 2018 that was registered during the first eight months, the year will end with $22.80 billion in exports, $62.02 billion in imports and the highest-ever trade deficit of $39.22 billion. These projections will also increase the current account deficit in FY 2018.

A country running a current account deficit is a net importer of capital. The capital may be imported in the form of non-debt creating instruments – such as foreign direct investment (FDI) – or debt-creating instruments – such as bilateral and multilateral loans and the sale of bonds (Euro bonds, for example). Over the years, Pakistan has only been able to attract gobbets of FDI inflows. Between FY 2013 and FY 2017, $8.85 billion was made inFDI, which amounts to $1.77 billion per annum on average. The situation has forced the government to rely on foreign credit to finance the current account deficit.

The result is a massive external debt, which has gone up in one year from $75.75 billion (as recorded on December 31, 2016) to $88.89 billion (as noted on December 31, 2017). This is in addition to Rs15.79 trillion in public domestic debt (as recorded on January 31, 2018), which is owed to domestic residents and institutions, and has been incurred to finance the budget deficit.

In 2018, Pakistan will start repaying the loan of $6.12 billion that it took from the IMF. This is likely to put pressure on the foreign exchange reserves (forex). On March 22, 2018, the liquid forex available with the central bank had come down to $11.77 billion. The meagre forex constrains the SBP’s ability to intervene in the foreign exchange market to reduce downward pressure on the value of the rupee.

Elementary economics dictates that the difference between the savings and investment in an economy is equal to its current account deficit. As a result, Pakistan’s economy, which invests more than it saves, runs a current account deficit and relies on foreign savings in the form of borrowing or FDI. In FY 2017, the gross domestic savings-GDP ratio was 11.7 percent, considerably less than the 15.8 percent gross investment-GDP ratio. The IMF’s projected ratios at the end of FY 2018 are 12.2 percent for savings and 17 percent for investment.

Low real interest rates must take the flak for the low level of savings. The SBP has adopted a fairly lenient monetary policy for quite some time. A discount rate of six percent was maintained from October 2015 to May 2016. In June 2016, the discount rate was reduced to 5.75 percent, which was raised by a whisker to six percent in February 2018. The latest monetary policy (April-May 2018) has persisted with the six percent discount rate even though the state of the economy warranted a higher interest rate. Low interest rates discourage savings and encourage spending. As a result, they contribute to trade deficits by driving up import demand.

Low domestic savings also indicate that the government has to rely on bank borrowing while financing fiscal deficit. During the first half of FY 2018, the federal government borrowed Rs573.93 billion from the banks out of the total domestic financing of Rs616 billion. The bank borrowing is inflationary and raises the cost of doing business. Borrowing from the central bank increases money supply and drives up domestic demand, which encourages imports. Not surprisingly, the IMF has been critical of our lenient monetary policy as well as the manner in which our fiscal deficit is being financed.

After keeping the exchange rate stable for four years, the government allowed the rupee to depreciate by five percent first in December 2017 and subsequently in March this year. Before the depreciation in both cases, the general view was that the domestic currency was considerably overvalued, which discouraged exports and encouraged imports.

In the wake of the first depreciation, both exports and imports went up. However, exports had increased by 10.52 percent during the first five months of the current financial year (July-November) – well before the December depreciation. The possible reasons were the generous rebates given to the exporters under the prime minister’s trade enhancement package and the increase in international cotton prices. Since the textile and clothing sector has the lion’s share in Pakistan’s exports, downward or upward movements of world cotton prices bear strongly upon export receipts.

At the same time, exports grew 16.47 percent in February 2018 on YOY basis but declined by 3.5 percent as compared with what it was in January 2018. It will, at best, be a conjecture to attribute export growth to rupee depreciation. However, the IMF believes that exchange rate depreciation is a recipe for racking up exports and, thereby, ratcheting down the current account deficit. The depreciation may also set the stage for the resumption of IMF assistance.

Apart from the galloping current account deficit, our shrinking forex also resulted in the depreciation of our exchange rate. Owing to the limited availability of forex, the SBP was hard-pressed to maintain the existing exchange rate by pumping dollars into the market. If the central bank or the government had not allowed the rupee to depreciate, the foreign exchange market would have seen an acute shortage of dollars and other hard currencies. How much the fall in the rupee value will serve as a catalyst to increase exports is anybody’s guess.

The PML-N regime will be the second popularly-elected government on the trot to complete its tenure. It is also likely to become the second government to start and close its term with a credit agreement with the IMF – the actual signing of the agreement, as it happened in 2013, may be put off until the caretakers or the new government takes office. In both cases, history will be made. The nation must brace itself for these twin historic events.

The writer is an Islamabad-based

columnist.

Email: hussainhzaidi@gmail.com