Pakistan’s macro outlook is on a tightrope yet again – a familiar habitat for the country’s economy! A confluence of unprecedented pressures and challenges is clouding the economic outlook, which is being exacerbated, in turn, by economic management being hostage to political expediency in the short run.
This is unfortunate, not least, because it may mean the derailment of the IMF programme but also since the PTI government has made significant progress over the last three years in several reform areas vis-a-vis the economy.
The path chosen by the government to navigate its political troubles risks reversing the gains made. Another implication of the foregoing is that while the finance minister is aiming for a ‘balanced’ growth, which is sustainable in the medium-term, the rising macroeconomic imbalances will force a choice sooner rather than later between achieving a ‘soft’ versus a ‘hard’ landing.
Any likely international support for a new political set up in Pakistan, assuming the no-confidence move against Prime Minister Imran Khan is successful, may delay the inevitable and set up a reflation trade on the Pakistan Stock Exchange, in our view. However, this is likely to be a brief interlude before the challenging external environment reasserts itself.
These observations were made by Sakib Sherani, leading economist and former member of the prime minister’s Economic Advisory Council, in a report, which was prepared by Sakib Sherani/Macro Economic Insights (SMC-Pvt) Ltd for KTrade Securities Limited.
Sherani said that under growing political pressure and right on the heels of a successful resumption of the stalled IMF programme, the government has announced a large “relief package” with subsidies on petrol and electricity. The untargeted nature of the subsidy and the uncertain financing raises the risk of a collision course with the IMF. The embattled government’s attempt to pull a rabbit out of its political hat comes in the backdrop of sharply higher uncertainty across a broader front from geopolitics to domestic politics, as well as the outlook for international commodity prices. The IMF factor is an unwanted add-on to the spectrum of uncertainty.
The interlude of relative stability for the external account, brought on by the return to the fold of the IMF programme, was already heading for a test beyond the near-term. Pakistan’s gross external financing requirement remains elevated with the external current account balance likely to be pressured upward by on fire international commodity prices and external debt repayments remaining high.
The medium-term outlook is compounded by geopolitical risks. The Russian invasion of Ukraine has ignited already elevated energy prices and is likely to send the global economy into a tailspin. Any withdrawal of stimulus and the start of the monetary tightening in the US is yet another lurking risk for the emerging markets, though this may be pushed further down the road now given the knock-on impact of the Russia-Ukraine conflict.
A continuation of the commodities ‘super-cycle’ will worsen the inflation outlook and have a knock-on impact on growth. The adverse effect on growth will compound the headwinds stemming from the greater fiscal consolidation required under the remainder of the IMF programme, assuming Pakistan follows through.
In the last three years, Pakistan has crossed many significant hoops of fire regarding the structural and institutional reforms related to both the IMF programme, as well as the Financial Action Task Force (FATF) commitments.
To its credit, the country has “moved the needle” on key areas of reform, most notably relating to exports, the autonomy of the State Bank of Pakistan (SBP), public financial management, trade policy and public debt management.
While a less-than-benign outlook for the international commodity prices and a less-than-stellar management of the economy over the last year cloud prospects in the near-term, or slightly beyond, the long-term outlook is positive, bolstered by structural reforms undertaken in the recent past that have not been sufficiently highlighted.
On February 2, the IMF Executive Board approved the stalled sixth review under Pakistan’s 36-month, SDR4,268 million Extended Fund Facility (EFF). This review was originally planned to be completed by June last year and had been delayed due to a reversal of fiscal consolidation in the 2021/22 federal budget, as well as a lack of progress on the key conditionality relating to the central bank independence and the energy sector.
The current EFF is Pakistan’s 23rd IMF programme since 1952 and the 13th since 1988, reflecting a history of boom-bust growth and stop-go economic reforms.
Pakistan’s recent return to the fold of its stalled IMF programme required crossing a few “hoops of fire”. These included withdrawal of tax exemptions and the general sales tax rationalisation, amounting to approximately 0.5 per cent of GDP; ensuring passage of the new SBP Act in parliament, granting full independence to the central bank; enacting the Nepra Act, empowering regulator to make automatic adjustments; announcement of the suspended increase in the electricity tariffs; recommit to the path of fiscal consolidation, etc.
Additional measures have also been made part of the revised programme conditionality.
As per the IMF staff report accompanying the sixth review, the new conditionality includes all structural benchmarks: preparation of draft personal income tax legislation; preparation of a plan by the Ministry of Finance and the State Bank of Pakistan in consultation with other stakeholders, to establish an appropriate development finance institution to support the eventual phasing out of the SBP refinance facilities; completion of the first stage recapitalisation of the two private sector banks that are undercapitalised; Cabinet decision on the second step of the energy subsidy reform for residential consumers; parliamentary approval of the new SOE law in line with the staff recommendations; the issuance of regulations by the Public Procurement Regulatory Authority to require collection for the publication of beneficial ownership information from the companies, which are awarded public procurement contracts for Rs50 million and above.
The implications of the new conditionality and programme targets, in a nutshell, are that Pakistan will be required to achieve greater fiscal consolidation via a combination of higher tax collection, as well as spending cuts.
So far in the programme, which came into effect in July 2019, Pakistan is lagging the target set for fiscal adjustment by an accumulative 1.4 per cent of GDP. The overall fiscal adjustment targeted under the programme (recently revised) amounts to 2.6 per cent of GDP.
The rising pressure on the external account forced the government’s hand to seek a quick return to the stalled IMF programme. Prior to this, the government’s strategy appeared to be to keep the IMF programme suspended as a matter of political expediency.
However, with the ink on the agreement with the IMF to restart the stalled programme not having dried (proverbially!), the government threw a curve-ball. Facing mounting political pressure from a resurgent opposition, buoyed by a double-digit inflation fed by the global commodity price inflation and adjustments in the administered prices under the IMF programme, the prime minister announced on February 28 an across-the-board reduction in petrol prices (Rs10/litre, or 6.2 per cent, at the prevailing retail price) and electricity tariffs (Rs5/unit, or approximately 30 per cent at the prevailing average tariff).
As per the announcement, the reduced prices will be frozen for a period of four months, i.e., till the end of the ongoing fiscal year on June 30.
The fiscal cost of the package at the time of the announcement was reportedly in the range of Rs250 billion to Rs300 billion (approximately 0.4 per cent of GDP on the new base), worked out when Brent was trading at around $94/barrel. At the prevailing price at the time of writing this note ($130/barrel, May contract, as of close of trading on March 8, 2022), the cost of the relief measures has already increased over 38 per cent, or by an additional 0.15 per cent of GDP.
A weakening of the rupee will also add to the fiscal cost of the package, commensurate with the extent of the depreciation.
In addition, the prime minister announced yet another tax amnesty or “money whitening scheme” (violating a continuous structural benchmark under the IMF programme). This one is aimed at fresh investment undertaken in industry and comes after an earlier one announced for the real estate sector that attracted substantial interest.
The monthly cash transfer under the country’s flagship safety net programme has also been increased from Rs12,000 to Rs14,000, while 2.6 million scholarships for students and 150,000 internships for educated unemployed youth were also announced.
The complete cost of the entire package of measures announced by the government is unclear. Even more unclear is the financing part. The finance minister has publicly said in various appearances following the government announcement that the package of measures will not affect the fiscal deficit and will be funded from the existing budgetary resources.
Even if the possible financing availability is as firm and hopeful as the finance minister believes, the ‘relief’ package measures have potential unintended consequences and raises a number of as-yet unanswered questions and concerns.
To summarise, the potential unintended consequences of the announced relief package appear to be as follows: a widening of the primary fiscal balance; negative reaction of the IMF; adverse impact on the power circular debt; pressure on the oil marketing companies (OMCs) cash flow; and an unfavourable effect on the trade deficit.
The IMF programme is likely to face an impasse due to the recent policy measures with the government unlikely to pursue significant fiscal consolidation, waiting instead to see off the lending arrangement in September this year.
The overall policy mix is likely to remain insufficiently defensive and inappropriately accommodative in the face of the rising macroeconomic pressures.
A major wildcard and a key risk in the medium-term for the external account relates to the political heat the PTI government is facing. Beyond the pressure generated by the no-confidence move against the prime minister being orchestrated by the opposition parties, general elections are scheduled in 2023.
Facing a string of by-election losses, the most for any sitting government in Pakistan’s recent history and a depletion of the political capital due to stubbornly high food inflation and upward adjustments in administered prices, the government is very likely to go into “election mode” later this year.
This raises the acute risk of increased balance of payments stress just as the external buffers provided by a IMF programme are removed. It is no coincidence that all of Pakistan’s recent external account crises from 2008 onwards have coincided with the election cycles.
(The writer is a former member of the Prime Minister’s economic advisory council and heads Macro Economic Insights [Pvt] Ltd, a consultancy based in Islamabad)