Fiscal challenges all around

September 02, 2019

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Economic challenges have deepened as the PTI government enters its second year in power.

The national security situation is alarmingly tense after India annexed Occupied Jammu and Kashmir on Aug 5. If the situation worsens amidst Indian stubbornness, it will further complicate these challenges.

Pakistan has been struggling for years to keep its fiscal and current account gaps in check, but the twin deficits are there. The latest update on fiscal operations is that the fiscal deficit in 2018-19 was just too high — 8.9 per cent against the revised budget estimate of 7.2pc and the original estimate of 4pc.

The additional deficit of 4pc of GDP or Rs1.54 billion is not only shocking, but also alarming. What else is alarming is that the PTI government financed the bulk of the fiscal deficit through borrowings from the central bank. That is why we saw inflation shooting up and that is why a tight monetary policy was adopted throughout the year to check inflationary pressures.

Bringing the fiscal deficit down from 8.9pc of GDP in the current fiscal year — and that too without additional borrowing from the central bank — simply looks impossible.

This means the government will have to make harsher cuts in development spending during this fiscal year and that, in turn, will make the achievement of even a very low GDP growth target of 2.4pc quite difficult.

It is against this backdrop that the government has realised it made a mistake by hitting the private sector with a double whammy of tight monetary policy and NAB investigations. That is why it recently announced that NAB would now spare the private sector. It is now asking the central bank to find ways for a gradual loosening of its tight monetary policy.

Foreign investors are likely to adopt a wait-and-see policy and reassess the risks associated with strategic investment

Appalled by huge external debt servicing coinciding with the twin deficits, the PTI government opted for foreign exchange borrowing from three friendly countries i.e. China, Saudi Arabia and the United Arab Emirates. Then it went to the IMF for a three-year bailout of $6bn. At the same time, it worked on improving its embittered ties with the United States. Improved relations with Washington were expected to help in attracting foreign investment and trade from the United States and elsewhere. But on August 5, India stripped the people of Occupied Jammu and Kashmir of their special status by force and that shattered the status quo in the security environment of both Pakistan and India.

Now foreign investors are likely to adopt a wait-and-see policy and reassess the risks associated with strategic investment. A legitimate pressure on national resources can erupt if security challenges deepen further, upsetting earlier fiscal projections.

So avoiding the repeat of the twin-deficit story has now become a pressing issue for Pakistan. That is possible by accelerating economic growth, faster than the previously set target of 2.4pc for this fiscal year.

That is why reversing or putting on hold the current tight monetary policy and ensuring the exchange rate stability are being touted as a panacea by top policymakers in Islamabad.

But mobilising enough revenue and boosting non-debt creating foreign exchange earnings are prerequisites for achieving the twin objectives.

Policymakers believe that a gradual easing in monetary policy can help revive industrial growth and boost the economy, thus enabling the government to keep the fiscal deficit in check. They suggest that an interest-rate subsidy should be offered to export-oriented industries while making a gradual reduction in overall interest rates.

How this will pan out in the next three quarters of this fiscal year is hard to predict. But the push for this idea is strong as it has come from Imran Khan himself and reportedly has the blessings of the ‘establishment’.

But as for now, all is not well on the external account. The current account deficit, which was $2.13bn in July last year, has come down to just $579 million. This has happened primarily because the deficit in goods and services trade fell to $2.32bn from $4bn. But when you dig deeper, you find out that imports of goods and services plunged and exports grew only nominally. Imports of goods and services declined from $6.44bn in July 2018 to $4.97bn in July this year. But exports of goods and services inched up from $2.44bn to $2.65bn.

Besides, foreign exchange reserves of the central bank ($8.27bn) are still insufficient to cover even two months of the merchandise import bill. Overall foreign exchange reserves, including those of the central bank and commercial banks, are only a fraction ($15.63bn) of Pakistan’s total external debts and liabilities amounting to $106.3bn.

We should be prepared to see our import bill rising in coming months because imports of strategic commodities, including oil, will increase in the midst of a challenging national security environment. Besides, if international oil prices rebound owing to the US-Iran conflict, that too can fatten the import bill. We should not expect a miraculous increase in exports shortly because efforts to reinvigorate export-oriented industries will take time to bear fruit.

After hitting an all-time low of 164.05 to a dollar on June 27, the rupee has since recovered some lost ground. On Aug 29, it closed at 157.22, showing a cumulative gain of 4.16pc in two months.

External debt servicing will consume more foreign exchange in 2019-20 owing to a net addition of $11bn in external debt and liabilities in 2018-19. Hence, sustaining the rupee’s gains will remain a challenge. In 2018-19, external debt servicing ate up $11.6bn.

Published in Dawn, The Business and Finance Weekly, September 2nd, 2019