Navigating through economic landmines

It seems that the PTI government is focusing on short-term arrangements

Navigating through economic landmines

The national economy seems to be in a continuous struggle for revival. It has many structural challenges that need to be addressed. These includes a weak revenue collection mechanism, a challenging business environment, huge loss-making state-owned enterprises and high circular debt.

After coming into power, the Pakistan Tehreek-i-Insaf (PTI) government made tall claims about economic governance and management. Instead, it has delivered economic mismanagement, large deficits, below par growth in exports in view of abnormally high devaluation and high inflation. All this is tearing apart macro-economic buffers.

The pressure on reserves has again started to mount; the current account posted a $3.4 billion deficit (4.1 percent of GDP) for Jul-Sep FY2022 against a surplus of $865 million (1.2 percent of GDP) last year. The Ministry of Finance believes that the current account deficit has widened due to constantly growing import volume of energy as well as non-energy commodities and a rising trend in the global commodity prices, food and metals.

As per Pakistan Bureau of Statistics (PBS), during Jul-Sep, FY 2022, exports increased by 27.9 percent to $6.9 billion (over $5.5 billion last year). Exports grew by 27.7 percent to $2.4 billion (against $1.9 billion last year),

The imports in the same period increased to $18.7 billion (as against $11.3 billion last year), posting a massive increase of 66.1 percent. The main imported commodities were petroleum products, palm oil, petroleum crude, iron and steel, liquefied natural gas, medicinal products, plastic materials, textile machinery, electrical machinery and apparatus, power generating machinery and raw cotton.

The export sector is currently doing well. The government needs to support and strengthen it by offering affordable inputs like energy and attractive cost of funds and a reduced rate of duties on import of raw material and machinery.

The World Bank has reported that export market share of Pakistan had declined since 2000 wherein, only $13 out of $10,000 worth of goods and services exported worldwide originated from Pakistan. In 2020 this came down to $11—the decline is across all sectors. Pakistan’s share in the global market for hides and skins, for example, shrank from 1.5 percent in the early 2000s to 0.8 percent in 2020. The share of Pakistan’s flagship export sector, textile and apparel, dropped from 2.3 percent to 1.8 percent over the same period. New sectors, especially ICT, must be promoted in order to diversify the export portfolio.

Already, Pakistan has limited external buffers. With imports and financial liabilities increasing simultaneously, the impact on exchange rate has been unprecedented. This heat is causing the meltdown of reserves. Earlier in September 2021, Morgan Stanley Capital International (MSCI) announced a downgrade of Pakistan from Emerging Market (EM) Index to the Frontier Markets (FM) Index.

This is one of the reasons that took funds away from Pakistani equities. Consequently, in the first three months of the current financial year, Pak rupee has been amortised by more than 8 percent. The World Bank recently reported that between mid-June 2021 and early September, the State Bank of Pakistan (SBP) pumped in approximately $1.2 billion in the market in an attempt to support the sliding rupee.

Already, Pakistan has limited external buffers. With imports and financial liabilities increasing simultaneously, the impact on exchange rate is unprecedented. This heat is causing the reserves meltdown.

The external public debt forms a major component of the country’s total debt. Given the continuous depreciation of the currency the debt and liabilities are now almost equal to the GDP. External and public debts have reached alarming levels igniting a depletion of international reserves. To address these challenges, Pakistan has had to look for a helping hand every few months. The begging bowl is getting bigger and bigger as financial sovereignty as well as economic security have been a casualty; even defence expenditure is now met from borrowed funds.

The foreign lender’s control of economic decisions is getting stronger. From transactional matters like determination of utility prices to strategic matters like taxation rates lenders influence the decisions without any concern for the impact and adversity on general public and businesses.

Then there is budget financing by the SBP. The global lender discourages financing of the budget by the SBP which increased from around Rs 3.6 trillion in FY 2018 to over Rs 7.7 trillion in 2019 (around 20 percent of the GDP).

While entering into financing facility from the International Monetary Fund (IMF), the SBP and the Ministry of Finance had agreed to re-profile the existing debt into tradable instruments at least to market interest rates. This is done with the purpose of imposing financial discipline and to force the government to spend according to its earning.

However, the government resorted to secure financing primarily from domestic commercial banks, through the issuance of Pakistan market treasury investment bonds and sukuks—these have increased debt-servicing cost for the government. Resultantly, the already narrow fiscal space is getting narrower for any new and meaningful initiative.

In the international arena, oil prices are hovering around $85 per barrel which is the highest since October 2018. In fact, the entire energy chain prices have witnessed a strong jump in the past couple of months. The PTI government has made attempts to absorb these shocks by compromising on petroleum levy and sales tax. However, considering the limited fiscal space available with the government, this cannot continue for long and public is at the risk of greater exposure to the tsunami of inflation.

The PTI government is managing its finances by adopting unconventional methods, like dallying energy payments and tax refunds, etc. The stock of tax refund claims that have not been settled as of December 2020 has mounted to Rs 499 billion. Further, as per the disclosures in the State of Industry Report 2021 of National Electric Power Regulatory Authority (NEPRA), circular debt in power sector had crossed Rs 2.3 trillion mark by June 2021.

This inefficient fund management is creating cash flow problems for industry. Delayed refunds force companies to arrange financing at commercial banking rates in order to meet their day to day expenses and rising circular debt results in frequent increases in electricity tariff pushing inflation to new heights—there are indication that it will be in double digits if curative measures are not taken. The common man is already going through hardship.

The PTI government must be cognizant of the fact that economic expansion can again lead to higher current account deficit forcing its funding from the financial support by developed nations or global lenders. It seems that the government has no concrete plan to address these challenges except focusing on short-term and makeshift arrangements to bridge the ever-widening fiscal gap. Standing on the verge of default, alarm bells are ringing. Ad hoc-ism can cause a further deterioration of the overall fabric of the economy.

Abdul Rauf Shakoori is a corporate lawyer based in the USA and an expert in white collar crimes and sanctions compliance. Dr Ikramul Haq, Advocate Supreme Court, is adjunct faculty at Lahore University of Management Sciences; and a member of the Advisory Board and a visiting senior fellow of the Pakistan Institute of Development Economics

Navigating through economic landmines