In the context of an IMF programme soon to be launched in Pakistan, it is important to identify and analyse the basic issues of the national economy and find ways to solve them.
One of the most serious problems is the rising public debt. At almost 80 per cent of GDP, Pakistan’s public debt is projected in 2020 to be the highest among emerging market countries. But the real threat is the public financing needs, which in 2020 are estimated to be 46pc of GDP, and more than three times the IMF’s 15pc of GDP high-risk threshold for emerging markets. The IMF estimates that by 2020, the budget deficit would rise to 9pc of GDP which is 5pc higher than the government’s own 4pc of the GDP limit set in the Fiscal Responsibility and Debt Limitation (FRDL) Act, 2005.
While implementing IMF conditionalities, what homegrown strategy can we adopt to lessen the pain of fiscal and monetart adjustment? One way is to apply cuts in core government expenditure, but it is not easy.
Administrative expenditure is inflexible, while social and development spending is already at critical levels and the military budget cannot be touched due to ongoing border tensions. But we can do some tinkering with the loss making state-owned enterprises; and subsidies on petroleum, energy and sugar. The former will require layoffs and higher user prices; the latter will involve further tariff increases and tougher action against pilferage. While not easy politically, the government can ill-afford to bear these largely regressive handouts anymore.
Given our extremely narrow tax base, the IMF has demanded the elimination of tax exemptions and harsh measures against tax evasion. This will pit the government against the entrenched interests of the agricultural and real-estate sectors, self-employed professionals and small businesses, and even some established industries. These are tough reforms and long-overdue and cannot be avoided any further.
But beyond fiscal consolidation, there are issues relating to debt repayments. Much of Pakistan’s public gross financing need is due to its short (two-year) maturity of debt: amortisations in 2020 are projected at 37pc of GDP, just under half of the total debt stock. To bring these down to reasonable levels, the government may have to consider re-profiling its domestic, and even some of its external, debt. Then, in the medium term, a strategy should be put in place to maintain an average debt maturity of at least five years. This will be far more effective than any limit on the level of the debt-to-GDP ratio.
The challenge is greater on the external financing front. On current policies, Pakistan’s cumulative current account deficit over 2019-2023 is projected at about $60 billion. If we include external debt amortisations of about $40b, the total debt rises to $100bn, a third of Pakistan’s GDP.
Pakistan does not have any foreign exchange buffers to meet the requirement. The support from Saudi Arabia and the UAE was short term, and it could not help close the medium-term gap. In these circumstances, the IMF will likely demand full exchange rate flexibility to help reduce the current account deficit. But this will not be without costs: currency depreciation will raise inflation (weakening our competitiveness), as well as the burden of servicing external debt. Thus, even if necessary to stabilise foreign exchange reserves, further exchange rate depreciation may not bring much net benefit in terms of reducing the external financing gap.
This means some sort of a rescheduling of external debt obligations will be needed. While the breakdown of the $40b external debt amortisation is not known, the information in the IMF’s 2018 First Post-Program Monitoring Report suggests that about half of it is likely to be owed to official bilateral creditors (with China in the lead, followed by Saudi Arabia, the UAE and the Paris Club). If all of these creditors agree to reschedule their claims by five years, it could save the government $20b in foreign exchange reserves over the life of the IMF programme.
Reportedly, half of the remaining $20b is owed to multilateral institutions and half to commercial creditors. Multilaterals will not be receptive to a rescheduling request, but, with an IMF programme in place, they should be able to provide new financing in excess of the amounts falling due to them. One can assum they could provide net financing of about $10b.
This leaves the debt to commercial creditors. Because of its relatively small size, it may not be worth renegotiating the debt. In this context, the Pakistan government would be well advised to examine the successful debt exchange undertaken by Mongolia in March 2017, just after its staff-level agreement with the IMF.
If the strategy is followed, it will provide some breathing space to the government. It would also benefit the creditor community as a whole, as its claims on Pakistan would have a better chance of being repaid over the medium term. But, most importantly, it would ensure fair burden-sharing of the required adjustment between the government, its taxpayers, and its creditors. Pakistan is in a challenging economic situation and it must play its cards well to get out of its predicament.