Worrisome outlook

Published May 11, 2022

THE PSX meltdown on Monday signalled the market’s growing concerns over worsening economic fundamentals and a disturbing near-term outlook due to the government’s indecision on economic challenges.

The one-day drop of 2.23pc in the benchmark KSE-100 Index wasn’t huge. Investors have seen worse days. But the fact that the market is hovering around the current levels, rising a bit on isolated good news only to fall again, for many months now, exposes the underlying economic vulnerabilities and investors’ waning confidence.

The latest fall was driven by a combination of factors ranging from deteriorating fiscal conditions, increasing external-sector difficulties, political uncertainty ahead of the next budget and bearish trends overtaking global stock markets on rising US interest rates.

But the most important factor has been the failure of the new coalition government to come up with a credible plan to take politically tough decisions to fix the economy. For example, it remains undecided about the reversal of the fiscally unsustainable energy subsidies, which is the ‘prior action’ that IMF wants it to take before it agrees to restart funding.

That’s not all. There are differences within the PML-N on how to deal with the Fund, with former finance minister Ishaq Dar, who is opposed to IMF ‘dictation’, wanting a new loan with ‘softer’ conditions. If the strings of the finance ministry are being pulled from London, then Finance Minister Miftah Ismail has his hands tied.

However, this isn’t the only factor keeping the PML-N from removing the cap on energy prices. The fear of a political backlash at a time when Imran Khan is working hard to bring large crowds to Islamabad this month is also keeping the government from taking tough decisions. The problem with the energy subsidies is that the government may decide not to reverse them in the hope of avoiding greater inflation. But the trade-off would mean significantly boosting the fiscal deficit, forcing more bank borrowing since foreign flows have dried up. That, in turn, means pushing interest rates and will delay the revival of the IMF programme, constraining options to secure dollars from both multilateral and bilateral lenders, as well as raise commercial loans.

With State Bank foreign exchange reserves down to around $10bn, the nine-month current account gap at over $13bn and no hope of additional financing coming from friendly countries without an IMF deal, the rupee remains under pressure, fuelling inflation and driving up interest rates, something the new set-up wants to avoid. No matter what, energy prices will have to be increased if we want the much-needed IMF programme to avoid default on our external payments over the next several months. Indeed, the government will have to pay the political cost. But can it avoid the inevitable by refusing to take crucial decisions? Stock market meltdowns should be the least of our worries for now.

Published in Dawn, May 11th, 2022

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