Fiscal challenges loom large

July 08, 2019


Challenges will not go away during this fiscal year. They will continue to test the political wisdom of the PTI government and the proficiency of its economic managers.

The International Monetary Fund (IMF) has approved the six-billion-dollar loan. This is going to embolden other international financial institutions to top up their previous commitments with additional funds. For example, Asian Development Bank (ADB) is expected to offer $3.4bn additional funds of which $2.1bn will come during this fiscal year.

The IMF lending is also going to encourage global foreign investors to invest in Pakistan. Out of the $6bn IMF loan, $1bn is coming immediately and the remaining $5bn will follow in 13 quarterly instalments. The Fund will examine closely the pace of implementation of the reforms programme we have agreed with it before releasing each instalment. That is where the wisdom of the entire political class, particularly of the ruling PTI, will be tested. And that is where the acumen of our economic managers will also be tested to the limit.

Achieving substantial growth in export earnings seems too difficult as subsidies on imports meant for export-oriented industries are being withdrawn

Undertaking broad fiscal reforms that envisage the phasing out of energy subsidies and the taxing of the untaxed can infuse more heat to an already hot political environment. And if the effects of subsidy withdrawals are not mitigated, they can continue to fuel inflation. In the last fiscal year, average inflation stood at 7.3pc, far higher than 3.9pc a year earlier.

What is more disturbing is that the annual average reading on the Sensitive Price Index (SPI), which measures inflation for the poor, skyrocketed to 7.8pc in 2018-19 from just 1.6pc in 2017-18. Inflation remained high in the last fiscal year despite a massive 5.75 percentage-point increase in the policy rate. That much monetary tightening in a single year occurred in the backdrop of frequent rupee depreciations as external debt ballooned and increased the cost of external debt servicing. The rupee lost 31.7pc value against the dollar in 2018-19, which was a big reason for higher inflation.

Finance Adviser Dr Abdul Hafeez Shaikh says Pakistan will have to spend this fiscal year $11.8bn on external debt servicing, up from $9.5bn from the preceding fiscal year. The $6bn IMF loan spread over 39 months looks small when seen in the context of rising external debt servicing. To overcome that issue, Dr Shaikh proudly points out that the IMF funding will pave the way for additional funding from international financial institutions and even rollovers of existing loans. If we want to reduce our reliance on foreign loans, we need to lift declining exports, sustain growth in remittances and attract more foreign investment.

Exports are suffering from structural weaknesses and remain stagnant. Achieving a substantial growth in export earnings — and that too at a time when tariff subsidies on imports meant for export-oriented industries are being withdrawn — seems too difficult. Sustaining the growth rate in remittances also remains a challenge due to the localisation of jobs in the Gulf region.

Foreign investment will depend on domestic political stability, regional peace and investment policies and practices. Political stability is low and the US-Iran confrontation is making regional peace elusive.

The ongoing alleged political witch-hunt by the government cannot be dismissed as collateral damage of accountability. This is adding to political instability and making the prospects of growth in domestic investment bleak. The government and those who wield real power in Pakistan need to keep the accountability process clean.

On the fiscal front, the introduction of a single treasury account is going to help discipline government finances, make them more transparent and minimise the prospects of misappropriation. A gradual shift of all federal government deposits from multiple accounts maintained at various commercial banks to one account with the central bank may create a liquidity crunch. But since the shifting of deposits will be gradual and spread over years, this can be taken care of.

Right from the beginning of this fiscal year, the Ministry of Finance has started placing new deposits in one consolidated treasury account, which means commercial banks cannot get fresh government deposits. The ministry and the State Bank of Pakistan (SBP) are working out a mechanism to smoothly transfer the previously placed deposits with commercial banks to a single treasury account. The federal government’s decision to stop borrowing from the central bank from this fiscal year is going to help commercial banks increase their risk-free lending to the government. But whether and to which extent it can crowd out the private sector is yet to be seen.

The government claims its tax amnesty scheme led 137,000 people and businesses to report to the Federal Board of Revenue (FBR) hitherto undeclared assets of Rs3 trillion. Can this really help boost tax revenues and reduce the government’s need to borrow from banks? In that case, banks may have enough room to lend to the private sector. But we don’t know.

Unlike previous years, the government has not set a target for private-sector lending for banks. The projected economic growth for this fiscal year is also lower — 2.4pc against 3.3pc of last year’s. In addition to the fact that the banks’ effective lending has risen sharply, lower growth prospects may keep the private sector’s appetite for borrowing limited. This will enable banks to lend generously to the government. But until the progress potential of the private sector is unleashed, revitalising economic growth in the medium term will become a big challenge. Large-scale manufacturing growth recorded a slump of 3.51pc in the last fiscal year. It will be interesting to see how the government enables this sector to reverse the trend in 2019-20.

If inflation remains high and joblessness continues, accelerating domestic demand will be too difficult. Why will the large-scale manufacturing sector produce more when our exports are not picking up despite massive rupee depreciation? Taming inflation in the short term and even reclaiming the job losses caused by the decline in GDP growth from 5.2pc in 2017-18 to 3.3pc in 2018-19 are not that easy.

Monetary tightening contains inflation with a time lag. One can argue that the interest rate hikes of 2018-19 will keep inflationary pressure under check this fiscal year. But the rupee depreciation in 2018-19 will also continue to have a lagged impact on inflation this fiscal year. If the rupee falls further, chances for which remain strong owing to existing external-sector imbalances, inflation may rise further. The new fiscal year, too, is full of challenges.

Published in Dawn, The Business and Finance Weekly, July 8th, 2019