The IMF has once again adopted a soft and sympathetic approach to reviewing Pakistan’s performance under the Extended Fund Facility. Two key quantitative performance criteria on net domestic assets (NDA) of the SBP and the fiscal deficit target were missed, as well as the indicative target on tax revenue. Despite this, the ninth review has been successfully completed.
The economic projections made for 2015-16 are also on the positive side. Real GDP is expected to grow by about 4.5 percent. Inflation is likely to remain low and rise only up to 4.5 percent by the end of the fiscal year. The foreign exchange reserve position is considered satisfactory at $15.2 billion, rising by $1.7 billion in the first quarter of 2015-16.
The failure to meet the fiscal deficit target, primarily due to a shortfall in FBR revenues, is ominous. Already, the target for reduction of the deficit from 5.3 percent last year to 4.3 percent of the GDP in 2015-16 looks unattainable. There was a shortfall of Rs 40 billion in attainment of the first quarter FBR revenue target. Higher growth of revenues in October may be due to the delay in the filing of returns in September.
The government has already committed to cutting back the national PSDP for 2015-16 from the budgeted level by almost 25 percent. Then there is the additional fiscal cost of the Prime Minister’s agriculture relief package of almost Rs 120 billion and how this will be accommodated in the budget. The question is what are the additional measures of taxation and expenditure cutting that the Ministry of Finance has explicitly committed to as actions prior to the release of the next tranche? Like last year, are we in for a spate of mini budgets? There is need to bring these changes for approval before the National Assembly.
The economic projections also appear too optimistic. First, indications are that a GDP growth rate of 4.5 percent in 2015-16 is unlikely. The cotton crop has apparently failed and output could be down by almost 10 percent in relation to last year. Manufactured exports, especially of textiles, are also down. The closure of the Pakistan Steel Mill will negatively impact on the Quantum Index of Manufacturing. Falling commodity prices are likely to be accompanied by a lower supply response generally in agriculture. Altogether, a growth rate of above 3.5 percent looks unlikely.
The extremely worrying feature of the economy is the low level of private investment, despite the record low level of interest rates. The process of ‘crowding out’ from credit continues. Government borrowing from the banks has risen by almost ten times by mid-October over last year’s level. Also, there appears to be a reluctance to invest in the presence of low prices and limited growth of demand in the economy. For example, imports of textile and agricultural machinery have fallen by 10 percent and 46 percent respectively.
The rise in foreign exchange reserves in the first quarter of $1.7 billion is sizeable. However, over 75 percent of the increase is due to borrowings. This includes $500 million from the floatation of the Eurobond at a high interest cost, $505 million net credit from the IMF and $300 million of loans from multilateral and bilateral agencies. Non-debt creating capital inflows have been low. Foreign private investment (direct plus portfolio) is down by as much as 68 percent. There is no evidence yet that CPEC related capital inflows have started.
The substantial improvement in the current account deficit is welcome. However, it has been achieved by a bigger fall in imports than in exports. The former is due to a large decline in the oil import bill of 42 percent. From the view point of mid-term sustainability, the improvement in the current account deficit should ideally also come from higher exports. Currently, both export quantities and prices are generally down. The concessions offered up to now as part of the textile package are likely to be inadequate in significantly promoting exports. It will be interesting to see what the quantitative performance criterion in the IMF Programme is for net international reserves in the second quarter. This will indicate if there is agreement for larger market purchases by the SBP of foreign exchange, thereby putting more pressure on the rupee.
There is actually little improvement in the power sector. The latest Nepra report has been scathing in character. System losses have not significantly declined. Power generation has shown growth of only 3 percent in the first quarter. The Nandipur Project has been a near fiasco. Circular debt has piled up to over Rs 600 billion. Subsidies are being curtailed under IMF pressure by introduction of a large tariff surcharge, at a time when fuel costs are falling. This is yet one more reason for the declining competitiveness of exports.
The co-operative approach of the IMF is welcome. But the problem is that an overly positive assessment of the state of the economy creates a sense of complacency and reduces the commitment to structural reforms. A lot more needs to be done in the area of tax reform, improving performance of the power sector, stimulating private investment and exports, restructuring loss-making public enterprises, reversing the negative trend in social indicators and so on.
(The writer is the Managing Director of the Institute for Policy Reforms and a former Federal Minister)