Year of the fog

A handshake with the IMF continued to be just round the corner for the better part of the last quarter of 2018, but it never got going in real terms.
A handshake with the IMF continued to be just round the corner for the better part of the last quarter of 2018, but it never got going in real terms.

A THICK fog of uncertainty descended upon the economy at the beginning of 2018 that had not lifted till the end of the year. The uncertainty was driven by two things: the Dar growth years began to unravel as the rupee came unhinged by December 2017 and interest rates began to rise from January onwards; and the approach of the election brought questions over policy continuity.

For three years the economy had showed some signs of revival, between 2014 and 2017. Ishaq aDar never felt tired of pointing out the growth in the real sector, from construction to manufacturing, and vast new infrastructure schemes from roads and highways to power plants and ports. But one critical weakness emerged with ever greater urgency as the growth powered on and the public works neared completion: imports surged from $41 billion to beyond $56bn in this time while exports actually fell from $25bn in FY2014 to $22bn by FY2017, before clawing back some of that lost ground in FY2018 when they came in at $24bn, still below the level they were at when the growth rates began.

The growing trade deficit lay at the heart of the economy’s troubles. By the end of fiscal 2018, when the PML-N government handed over power to an interim government in preparation for the general election, the trade deficit came in at just below $37bn, when it had stood at just below $20bn by end of FY2014 when the growth rate began to rise. The government claimed this was due to large imports of capital goods, mainly machinery, for installation in the China-funded power projects, and, once operational, this machinery would help kick-start the economy and put it on a sustainable growth path.

The argument had some truth to it since machinery imports declined from the summer of 2018 onwards, once the projects under construction approached the start of commercial operations. But first-quarter trade data, covering the July-September period, showed the trade deficit at $8.75bn, whereas the same quarter in the previous year had it as $8.59bn. The growth had slowed down, but the elevated level of the deficit persisted, and as the year ended it was likely that the second quarter will show the same trend.

Investors want to see how long the new government will take to realise that a sharp economic adjustment is the only option.

In Dar’s years the economy powered on while the foreign currency reserves that were carefully built up using a combination of borrowing and bilateral assistance, first reached their peak in October 2016, and then began a steep decline that continued unabated through 2018. All through the year, the government and the central bank struggled to arrest this decline through successive rounds of rupee depreciation, interest rate hike, regulatory duties on imports, incentives for exporters. But all the efforts proved insufficient. The fiscal year ended in June 2018, precisely when an interim government was in place, and saw record high current account deficit of $18bn.

By the end of 2018, foreign currency reserves had fallen to a level where they were barely enough to finance two months of imports when the adequate level is internationally considered to be three months. Two credit ratings agencies – Moody’s and Fitch – raised the alarm in December that Pakistan’s debt levels were rising while reserves were falling, saying such a situation could take the country towards serious problems in servicing its current level of external debt. Fitch accompanied its announcement with a downgrade of Pakistan credit rating into junk territory.

The uncertainty created by the trade deficit and the attendant outflow of foreign currency was compounded by the uncertainty emanating from an approaching election and speculation about the outcome. If power was about to be handed over to a new government under the PTI – and in the run up to the election it was not clear who the victor might be – investors were worried about what sort of policies the new government would follow, how long it would take to realise the gravity of the economic situation it was faced with, and how far it will honour the policy commitments made by the previous government.

Under this fog of uncertainty, all investment decisions came to a standstill as the curtain fell on the PML-N government after their budget announcement in April 2018. Through the interim government, and past the swearing in of the new PTI government, investors waited in the wings to see how the new team is going to behave towards the economy before making any move.

Investors wanted to see how long the new government will take to realise that a sharp economic adjustment, which is painful and politically costly, is the only option. The leadership of the PTI was talking about recovering looted wealth stashed abroad, and reaching out to the Pakistani Diaspora as its main ideas about dealing with the large and growing foreign exchange crunch that was driving the economy towards a potential crisis.

This was highly unrealistic talk in the view of foreign investors, and the sooner the new government swivelled towards genuine policy steps – new revenues, expenditure cuts and currency depreciation – the more the markets would acknowledge that the government has a sound handle on the economy.

By September the realisation had begun to set in. A ‘mini budget’ totalling Rs800bn worth of a fiscal adjustment was announced, and by October the government had formally approached the IMF for a bailout. By the end of 2018, it appears that those talks will be wrapped up, and 2019 will open with Pakistan preparing to enter its 13th IMF programme.

The year will be remembered as the year Dar’s growth rates unravelled, and the economy drifted through the thickest fog of uncertainty it had seen in almost five years, only to emerge on familiar shores at the other end: the doorstep of the IMF and a sharp economic adjustment to bring its economic fundamentals in line with reality.



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