The International Monetary Fund has issued a new warning, stating that the government of Pakistan has frittered away the fruits of its three-year fund programme under which reserves were at an all-time high, growth was gaining momentum, and inflation was subdued. But Pakistan lost that moment of opportunity after exiting the IMF programme.
The warnings have been sounding for a few years now, especially since the visit of the IMF MD in October 2016. That was the month that reserves began their downward trajectory, on which they have stayed ever since. Now, an authority no less than the board of directors at the IMF is warning that matters are urgent and require immediate attention.
Last week, following its first post-programme monitoring (PPM) after the completion of fund programme in September last year, the International Monetary Fund expressed concern over Pakistan’s weakening macroeconomic situation, including widening external and fiscal imbalances, reduction in foreign exchange reserves and emerging risks to the economic and financial outlook.
The IMF’s post-monitoring report is a must read for other multilaterals and the rest of the creditors (barring China) or investors, as they see the Fund’s finding as a basic tool for decision making. The Fund in its previous programme was deemed to be too lenient on Pakistan as experts perceived that the US political clout on the Fund’s board was paving the way for a softer stance on Pakistan as the country was a key US ally in Afghanistan war.
Because of substantially higher credit outstanding from the IMF, the borrowing members have to face closer monitoring of the policies under the PPM and undertake more frequent formal consultation with the Fund than is the case under surveillance, with a particular focus on macroeconomic and structural policies that have a bearing on external viability. The IMF executive board also asked the government to immediately refocus on near-term policies to preserve macroeconomic stability and get back to fiscal discipline shown under the three-year $6.64 billion multi-tranche Extended Fund Facility (EFF) to minimise risks and economic distortions.
The IMF board has raised questions over the medium-term debt sustainability and called for additional revenue measures and containing expenditures. The board expressed its anxiety over the deteriorating assessment that the country’s fiscal deficit was set to hit 5.5 per cent of GDP — almost Rs505bn or 1.4pc — higher than 4.1pc budgeted by the government and current account deficit to touch 4.8pc of GDP with the economic growth rate staying conservative at 5.6pc instead of the budgeted 6pc. It may be noted here that the real GDP was estimated to grow by 5.6pc during the fiscal year 2017-18 due to improved power supply, investment related to the China-Pakistan Economic Corridor (CPEC), strong consumption growth and ongoing recovery in agriculture.
The IMF has pointed out that the near-term economic growth outlook was broadly favourable but “continued erosion of macroeconomic resilience could put this outlook at risk”. Therefore, it also 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.
Following significant fiscal slippages last year and current year deficit estimated at 5.5pc of GDP, 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. Alarmingly, gross international reserves further declining in a context of limited exchange rate flexibility. Against the backdrop 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 EFF arrangement in September 2016.
In the overall context, the IMF board directors welcomed the 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 them to minimise potential economic distortions.
Needless to say, the external sector pressures are in part linked to the fiscal deterioration during the last year and an accommodative monetary policy stance, as well as high imports related to the CPEC projects. In this situation, the government will need to strengthen fiscal discipline through additional revenue measures and efforts to contain current expenditure while protecting pro-poor spending and complementing the recent increase in the policy interest rate with further monetary tightening.
This is important to address inflationary risks and help reverse external imbalances. Side by side, the authorities will have to start accelerating structural reforms to reinforce macroeconomic stability, raise competitiveness and promote higher and more inclusive growth. In the aftermath of the recent setback due to the action of the Financial Action Task Force, the IMF board has called for further enhancing an anti-money laundering/counter-terror financing regime and strengthening the fiscal federalism and monetary and financial policy frameworks.
The government will also have to take steps to 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. Clearly, as per IMF’s advice, the government needs to urgently focus on short-term measures to contain the deterioration in the external and the fiscal accounts. Given that the year ahead is an election year which will see an interim government come and go, with an election in between, followed by the arrival of a new government, it will prove to be an increasingly difficult task to manage the growing economic imbalances.
This is also the year when the deficits, particularly on the external account, could grow to unmanageable proportions if present trends continue. Experts are of the opinion that the country is now back on a glide path towards another IMF programme, and yet another round of macroeconomic “stabilization” is on the horizon.