ANOTHER week, another reminder that the economy is now running on fumes. This time the reminder comes from Fitch Ratings, the global credit rating agency tasked with informing foreign investors and bondholders about the financial health of any economy they are looking to acquire stakes in.
The new government, they warn, will have “limited time to act” after coming into power since “external debt obligations pick up more rapidly in 2019”. Keep the calendar in mind: elections on July 25 mean it will likely be September by the time a government (with a cabinet) has been formed, unless things don’t go smoothly. There is a possibility that the deterioration in the external account will have slowed down by then (though not reversed), so the critical level of one month of import cover may not hit for a while longer. From January 2019, higher debt service-related outflows kick in, so the window to do whatever is necessary to build reserves will be those critical months from September to December.
“We expect the authorities to explore financing options after the elections,” says Fitch. Translation: they’re going to go shopping for dollars first thing after coming to power. This means a number of things. The new leadership will probably ask the Chinese for another billion dollars first, just like the couple of billion the Chinese have already provided (on terms unknown) since the budget to help shore up the reserves.
Depending on the answer they get, their next option will be to ask the multilateral donors, especially the World Bank and ADB. But both these institutions are now averse to lending purely for shoring up foreign exchange reserves, and whatever commitments they make rapidly will require high-level approval, meaning delays.
An IMF programme, if it should come to that, could complicate the implementation of CPEC.
After this, they will explore the possibility of a bond flotation, or raising foreign exchange through a swap, like the State Bank did in the summer of 2013. A bond flotation will be complicated, especially considering “Pakistan’s cost of external market financing has risen in recent months, with yields on the government’s November 2017 10-year Eurobond up more than 200 [basis points] since issuance,” according to Fitch.
“The cost could increase further amid continued global monetary tightening and rising geopolitical pressures. Vulnerabilities could be tested as rising debt-servicing payments start to add to external funding requirements from 2019.”
If there is a change in party after the elections, and recent polls suggest the electoral field remains wide open despite all the pageantry and hard work put into them thus far, then the new party will doubtless build its story with the same opening line that every government has used for the past 40 years: ‘we inherited a broken economy.’ It will be difficult to hit the roadshow circuit with a bleak story since investors will surely want to see a roadmap for renewal as well as a track record of credible performance.
It is under these circumstances that “an agreement with the IMF might become more viable”, says Fitch. But here too, there will be a problem.
Fund programmes almost always have a negative impact on economic growth. They are focused on another priority altogether: stabilisation. This means two things in Pakistan’s context: get the fiscal deficit down and the foreign exchange reserves up.
Bringing down the deficit is done through two means — raising revenues and cutting expenditures. In the 2008 programme, for example, there was a requirement to sharply cut back on subsidies and losses at the public-sector enterprises (the government was only partially successful in this). Power tariffs were hiked by 18 per cent as a prior condition, and interest rates were raised by 2pc, also as a prior condition. Fuel subsidies were already phased out much earlier. The combined impact of these actions, along with sharply curtailed development spending, was what economists call a ‘compression of demand’, which is a fancy way of saying folks had less money, or willingness, to spend.
An IMF programme, if it should come to that, could complicate the implementation of CPEC. Think about it this way: out of the Rs750 billion spent on the federal development programme last fiscal year (ended June 2018) Rs187.3bn was earmarked for CPEC-related projects, of which Rs119.2bn was the government’s own resources. And that’s just for fiscal 2018. In total, another trillion rupees need to be spent from the PSDP on CPEC projects alone in the years to come. So if a budget-cutting axe is to fall on development spending, it will need to be wielded in such a way as to not impact CPEC-related spending; this will take some skill.
The second complication will come from the overall slowdown in growth that necessarily accompanies all Fund programmes. Thus far, CPEC has been implemented in good times, when the economy was growing. The choices during this time have been over how to count and allocate its gains. But when the projects have to advance under conditions of sharply decelerating growth and fiscal consolidation, the choices involved will be about how to count and allocate its costs. That will be the real test.
The third complication will be a slightly more cerebral one. All Fund programmes require the country to open up its external and fiscal accounts for close scrutiny. The previous government got away with refusing to share CPEC financials with the Fund because by the time these financials matured, the country was no longer on a programme. The real picture of what the financial impact of CPEC projects will be will emerge at that point.
All this assumes, of course, that Pakistan will indeed go to the IMF. Although it is looking more and more likely, and past experience tells us to expect it, there is still a chance that something new, like a willingness from China to organise a bailout, could materialise. But it would be a mistake to count on that.
The writer is a member of staff.
Published in Dawn, July 5th, 2018