FeaturedNationalVOLUME 18 ISSUE # 42

Pakistan’s fiscal risk landscape

The Ministry of Finance has recently released its Fiscal Risk Statement (FRS) for the year 2023-24, shedding light on critical factors that pose potential risks and uncertainties to Pakistan’s fiscal outlook. The report highlights the challenges facing the country in the realms of policy implementation, sovereign guarantees, state-owned entities (SOEs), inflation rates, and external stability.

The ministry has identified several potential risks and uncertainties that could impact the fiscal outlook of the country. These include challenges related to policy implementation, increased sovereign guarantees, and the underperformance of state-owned entities (SOEs). Additionally, the report underscores the threat posed by record-high inflation rates to the country’s external stability.

According to the report, the federal government’s exposure to SOEs, in terms of outstanding loans and guarantees, reached 9.7% of GDP in FY21, while public and publicly guaranteed debt stood at 78.4% of GDP at the end of FY22. Notably, 37% of the total public debt is external debt, which carries currency risk. Moreover, the proportion of fixed-rate debt has decreased, currently accounting for only 26% of total public debt, increasing the risk associated with refinancing. Furthermore, the average time to maturity of domestic debt was 3.6 years for FY22.

The report focuses on various fiscal risks, with a particular emphasis on macroeconomic shocks, debt and guarantees, climate-related issues, natural disasters, SOEs, and public-private partnerships (PPPs). Among these, policy implementation and SOEs are highlighted as high-risk areas.

Global challenges such as supply chain disruptions, inflationary trends, and the prolonged Russia-Ukraine conflict are mentioned in the report, with the hikes in the central bank’s policy rate to combat inflation being noted as factors restraining economic activity.

Pakistan’s inflation rate has exhibited volatility in recent years due to factors like currency devaluation, global energy and food price fluctuations. The report also mentions the depreciation of the Pakistani rupee, influenced by trade imbalances, external debt, political instability, and global economic conditions. It acknowledges that economic activity during FY23 has been severely constrained due to several factors, including demand compression measures, agricultural losses caused by floods, uncertainty regarding the resumption of the IMF programme, challenges in meeting external financing needs, and maintaining foreign exchange reserves.

It expresses concerns about the deteriorating inflation outlook and heightened external stability risks. It identifies the uncertainty surrounding future adjustments in energy prices as a significant upside risk to inflation. However, it notes that a potential moderation in international commodity prices could contribute to lowering inflation, while the government is taking measures to reduce the fiscal deficit through initiatives like expanding the tax base, rationalizing subsidies, and promoting economic growth. External debt constitutes 40.8% of total public debt, which exposes the government’s fiscal position to vulnerabilities such as high current account deficits, low foreign exchange reserves, and a weakening exchange rate. A lack of foreign exchange reserves, coupled with large external payments, has led to liquidity issues and destabilized the exchange rate and domestic interest rates, further increasing the burden of external loans denominated in the local currency.

Ongoing fiscal deficits necessitate refinancing of maturing government debt and raising additional debt to cover fiscal shortfalls. High levels of short-term debt create significant refinancing challenges during periods of economic slowdown, larger fiscal deficits, or reduced investor confidence. Pakistan’s exposure to floating debt makes it susceptible to rising borrowing rates due to unfavorable economic conditions. Notably, the share of fixed-rate debt in domestic debt is 26%, whereas it constitutes around 70% in external debt.

To address these challenges, the Ministry of Finance is collaborating with the State Bank of Pakistan (SBP) and the Securities and Exchange Commission of Pakistan (SECP) to develop domestic debt capital markets and encourage participation from entities such as insurance companies and pension funds. The report also mentions the stock of guarantees, which accounted for 4.5% of GDP in FY22. It clarifies that guarantees issued against commodity operations are not included in the estimated stock due to annual limits on new issuances, as these loans are secured against the underlying commodity and are essentially self-liquidating. However, a fiscal risk arises from the lack of underlying collateral for a significant portion of commodity operations, resulting from issues such as theft of commodities, unpaid subsidies, and wastage during storage.

The report concludes by highlighting Pakistan’s extensive portfolio of SOEs, consisting of 204 entities, with 85 categorized as commercial enterprises. While these SOEs generate revenue for the federal government in the form of taxes and dividends, net inflows have been negative. This fiscal risk is exacerbated by the absence of a clear and comprehensive framework for public sector obligations (PSOs), preventing proper compensation for SOEs undertaking quasi-fiscal activities. This erosion of SOEs’ profitability, capacity to invest, and financial viability may not become fully apparent for years. Despite these challenges, SOEs provide essential services in various sectors to vulnerable consumers, making the complete elimination of quasi-fiscal burdens politically and economically infeasible.

In summary, the 2023-24 Fiscal Risk Statement underscores Pakistan’s fiscal vulnerabilities and the need for strategic measures to mitigate these risks. As the country grapples with challenges ranging from policy implementation and SOEs to external debt and inflation, it is imperative for policymakers to navigate these complexities while safeguarding the nation’s economic stability and resilience. It is also important to foster a comprehensive framework to address these fiscal risks, ensuring the continued provision of essential services to the citizens of Pakistan.