On the insistence of the International Monetary Fund (IMF), the federal government and the State Bank of Pakistan (SBP) did something last week that will deepen the ongoing political and administrative chaos, cripple the economy and multiply the miseries of 230 million Pakistanis. But they had to. Beggars cannot be choosers.

The federal government slapped a permanent debt servicing surcharge on electricity to generate Rs335 billion. This surcharge is the cruellest and most unjustified of all government levies. The government has levied it to partly reduce the circular debt of Rs800 billion parked in the state-run company.

This, in turn, is part of a much larger body of the country’s total circular debt — Rs2.523 trillion at the end of the last fiscal year in June 2022. Meanwhile, the SBP raised its key policy rate by 300 basis points to a 27-year high of 20 per cent. The central bank also let the rupee shed 7.4pc value in a single day and lick an all-time low of Rs285.09 per US dollar.

The government and the SBP did all this to ensure that the Fund revives this month its loan stalled last year and the country gets the last tranche of $1.1bn of the loan as early as possible.

The higher interest rate will likely attract portfolio investment in government bills and bonds, creating a temporary breathing space

The release of the IMF money will help attract some forex funds from foreign commercial and investment banks and from friendly states, including Saudi Arabia, China and the UAE. This means forex-starved Pakistan will skip sovereign default for the time being.

But to make sure that it never defaults on sovereign payments lot more needs to be done. The country will have to seek another, larger IMF loan in the next fiscal year starting in July and undertake structural energy, fiscal and external sector reforms.

The current National Assembly will complete its constitutional term in the third week of August. The caretakers installed to oversee general elections will have to initiate talks with the IMF for the new loan. But the deal can be made only by the new government that will be voted into power after the elections.

All this should happen within this year — if everything is according to the Constitution. Meanwhile, headline inflation is at an all-time high of 31.5pc — and food inflation in urban and rural areas stands even higher — 41.9pc and 47pc respectively.

Currently, Pakistan’s total liquid forex reserves held by the SBP as well as commercial banks stand at $9.268bn, of which SBP’s reserves are just $3.814bn. Even after unlocking the last tranche of the IMF’s loan and receiving the first instalment of promised forex funds from friendly countries, reserves-building will remain a challenge. The reason is Pakistan will soon have to remove curbs on imports.

The IMF wants this to happen. And industries and businesses across Pakistan are warning that if the regular opening of import letters of credit is not allowed, the country will run out of many imported raw materials and even food and medicine.

That is where the current unprecedented 300bps interest rate hike will become helpful in one way. The higher interest rate will likely attract portfolio investment in government bills and bonds. This “hot money” will create a temporary breathing space.

But external debt payments of $6bn due between now and end-June means one cannot expect a major and durable recovery in the rupee value in the months ahead. The rupee’s overnight recovery from Rs285.09 per US dollar on March 2 to Rs278.46 on March 3 was just the result of profit-selling.

There are also no chances for exports to grow too fast in the coming months on exchange rate advantage. Withdrawal of energy subsidies coupled with the recent hiking of energy tariffs, historic high-interest rates, and the current heightened political turmoil may prevent export growth.

Remittances’ response towards the rupee depreciation will be neutral on balance. On the one hand, there are chances that part of Pakistan’s ill-gotten wealth stashed abroad may start coming back disguised under remittances.

But on the other hand, average overseas Pakistanis who finance the expenses of their families in Pakistan may now remit even lesser volumes of foreign exchange if they don’t want an increase in these expenses in the rupee terms.

The SBP’s interest rate hike and the consequent increase in the yields of treasury bills and bonds may, however, attract additional short-term investment from overseas Pakistanis, as is expected from foreign portfolio investors of non-Pakistani origin as well.

More durable foreign investment will only come if the government increases the returns on foreign currency-denominated investment certificates for the Pakistani diaspora. But that will be too risky as higher interest payments on these certificates in foreign exchange will further aggravate the forex crisis.

Pakistan has long been relying on the IMF for a balance of payments support and harsh conditions imposed every time by the Fund are nothing new for Pakistanis. But this time around, the IMF conditions appear to be too difficult. Not meeting all the commitments frequently has also led to a harsher IMF attitude.

That said, there is an urgent need for a real “belt-tightening” — aimed at slashing all non-essential administrative expenses — instead of politically-motivated, self-deceiving cuts. There is also a need to ensure that even the most powerful people, institutions and businesses pay energy bills regularly.

Furthermore, the external sector has to be reformed to make exports gradually more competitive, incentivise and boost exports of IT and IT-enabled services and slash imports of non-essential consumer goods.

Published in Dawn, The Business and Finance Weekly, March 6th, 2023

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