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Economy to get a breather

July 08, 2012

THE expected reimbursement of the held up coalition support funds of $1.2bn by the US in the wake of reopening of Nato supply route will help ease financial troubles of our cash-strapped government.

The US announcement said the funds it owes to Islamabad would be released ‘very soon’, as several Nato supply trucks crossed into Afghanistan on Thursday.

“The release of the held up amount will provide the much needed breather to the economy and reduce government’s reliance on domestic borrowings for financing its budget deficit — at least for some time,” argues Mohammad Imran, dealer capital market at Soneri Bank.

The government’s domestic debt stock rose by 21.3 per cent to 7.30tr (including debt of Rs2.58tr from commercial banks, Rs1.57tr from the State Bank and Rs3.14tr from non-banking sources) in the first 10 months of the last fiscal to April from Rs6tr (including debt of Rs2tr from commercial banks, Rs1.32tr from the State Bank and Rs2.69tr from non-banking sources) a year earlier. Rising government borrowing has virtually crowded out private sector.

Analysts agree that the reimbursement of the CSF funds will release the growing pressure on exchange rate because of widening current account gap that was estimated to have expanded to $3.7bn or 1.7 per cent of GDP in the first 11 months of the last financial year to May.

“The promised amount is more than a quarter of the country’s current account deficit for the last fiscal. Thus, its reimbursement should have a salutary effect on the rupee and stop erosion in its value,” contends Sayem Ali, country economist for Standard Chartered Bank.

Going forward, he says, the CSF should boost government’s non-tax revenues, reduce its reliance on domestic borrowing from banks — particularly its need for printing new currency to finance its budget deficit, and bring down inflation to some extent.

Imran also feels that government revenues will go up and pressure on balance of payment situation ease. “Additionally, I think disbursement of the funds must push economic activity. There has always been a strong link between an increased economic activity and foreign capital flows. Take the example of the Musharraf era,“ he insists. He says the US statement promising to rebuild road infrastructure will also spur economic activity.

The expected cut in government borrowing from banks is likely to make more credit available for private sector. But will private sector use this opportunity to invest in capacity expansion and boosting production?

“It largely depends on removal of growing energy shortages and reduction in credit cost,” says a leading yarn exporter, who says the industry is ready to invest $5bn in as many years if favourable business conditions are created.

Revival of private investment, which fell 12.5 per cent of GDP last fiscal, remains a challenge for government, not least because of energy shortages and high borrowing costs on the back of the government’s appetite for funds from banking and non-banking channels.

“While managing external and fiscal pressures remain more of an immediate concern, the real challenge lies in reviving private investment,” said the State Bank in its last monetary policy statement.

“The scheduled banks continue to  avoid extending credit to private businesses, which are already suffering from energy shortages. Fiscal authority, on the other hand, is accumulating short-term domestic debt at a rapid pace.”

While the US money is expected to provide a breather, it is unlikely to have a long-term impact on the economy.

“What we needat the moment is sustained flow of foreign assistance for the next few years, especially in view of repayment of prematurely terminated IMF loan. We are supposed to repay $8-9 billion to the fund over the next two to three years. If we don’t receive foreign assistance on a sustained basis during this period, it will bring the country’s foreign exchange reserve under pressure and deteriorate balance of payments situation,” Sayem argues.

The SBP says the net flows in the capital and financial account were $1.4 billion last year. “Accounting for repayments of the IMF loans during the year, the SBP’s net liquid foreign exchange reserves have declined to $11.3 billion by end-May compared to $14.8 billion at end-June in 2011.”

The bank projects the size of current account deficit as percentage of GDP during the current year to be approximately the same as in last fiscal. “However, due to the anticipated rise in debt payments, the economy would need substantial external inflows to preserve foreign exchange reserves,” it says.

The yarn exporter, who did not want to give his name for personal reasons, is of the view that the renewal of the American financial assistance to Pakistan will be hugely helpful for the country’s flagging economy.

“Washington enjoys immense influence over multilateral donors like the World Bank and the Asian Development Bank. Improvement in our relationship with the US will help us get the stalled development and project funding from them. Besides, the US can also help in negotiating another loan from the IMF,” he asserts.

“We direly need immediate funding from multilateral lenders and donors because of the sharp drop in foreign private and bilateral official capital flows owing to sluggish global economic growth, partly due to the eurozone debt crisis,” he explains.

According to him, Pakistan requires multilateral assistance to close its widening budget deficit as well as invest in the construction energy and other economic infrastructure to kick-start the economy.

Many contend that critical fiscal reforms must be implemented to boost private investment and turn the economy around. “Government will have to bridge the gap between its income and expenditure to tame inflation and reduce credit costs. Unless this is done government will continue to need money to finance its deficit and banks will continue to invest in government securities and avoid lending to private sector to protect their profits,” a financial analyst at the MCB Bank says on the condition of anonymity. Additionally, he insists, private demand for credit too will not rise as long as energy crisis persists.

“The breathers like the release of CSF will not help the economy in the long-term. The long-term solution to our economic and financial problems lies in good governance and fiscal reforms.”