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Sailing in rough waters

July 23, 2012


Increasing political instability on the back of ongoing standoff between the coalition headed by the Pakistan People’s Party and the judiciary is feared to drag the economy further down as yet another prime minister faces the axe from the Supreme Court on July 25 for not writing to the Swiss authorities.

The court has already sent Yousuf Raza Gilani packing in June for refusing to comply with its order and it is unlikely to back down from its ‘well-established’ position when Raja Pervez Ashraf submits his reply.

The standoff between the PPP and the judiciary has severely hampered the government’s ability in the last four years to frame effective economic policies and implement governance and financial reforms to salvage the sliding economy.

The military’s relationship with the government too is widely believed to be deteriorating, especially after the American marines took out al-Qaeda leader Osama bin Laden in his Abbotabad hideout on May 2 last year.

The ‘factious relationship’ between Pakistan’s elected political leaders, the judiciary and the military undermines the government’s ability to formulate policies to address the country’s pressing domestic economic challenges, to bolster investor confidence and to attract much needed external financial support from official creditors and donors, according to Moody’s Investors Service.

The international rating agency had raised questions about Pakistan’s credit worthiness and downgraded its sovereign rating deeper into the junk territory on July 13, citing increasing political instability and the country’s deteriorating balance of payments position.

The main driver of the move “is the increasing strain on the country’s external payments position as a result of a rising trade deficit and decline in capital inflows,” Moody’s said.

Moreover, weak government finances, structural inflationary pressures  and domestic political uncertainties are adding to the country’s external vulnerabilities and debt sustainability, compounding pressure on its sovereign creditworthiness, it said.

The outlook is negative and the agency may downgrade Pakistan again  if its domestic political environment worsens and the policy framework and investor confidence deteriorates further.

It is probably because of the domestic challenges that Moody’s ignored the recent improvement in the relationship between Islamabad and Washington following the reopening of the Nato supply route after seven months of closure while lowering its rating.

Many analysts wonder as to the ‘odd’ timing of the downgrade that does not take into Account expected resumption by the United States of disbursement of the held upcoalition support fund (CSF) of $1.2bn. But others argue that the American dollars are too few to bring about any significant improvement in the country’s deteriorating balance of payments situation, when political tensions are escalating and upcoming elections keeping government’s focus away from the structural reforms to fix the economy.

“The CSF amount said to be on its way to the State Bank’s dwindling foreign currency reserves is too small compared to the upcoming large IMF debt repayments and the country’s rising oil import bill,” says a financial analyst working for a brokerage company on condition of anonymity.

He, however, concedes that disbursement of the CSF funds should help  provide some cushion to the deteriorating current account and somewhat reduce the government’s domestic borrowing needs in the short- term.

The latest economic data released by the State Bank shows that current account has deteriorated to $4.5bn or 1.9 per cent of gross domestic product (GDP) in 2011/12 from a surplus of 0.1 per cent the previous year, not least because of rising trade deficit of $15.39bn, up by almost 50 per cent from $10.5bn a year earlier, on surging oil prices.

Exports slowed by 2.8 per cent from $25.35bn to $24.65bn on growing energy shortages and falling global cotton prices and imports escalated by 12 per cent from just below $36bn to $40bn. Foreign currency reserves have dropped to $14.9bn from $18.24bn at the end of 20010/11.

The capital account too remained under pressure due to deterioration in Pakistan -US relation in the wake of closure of Nato supply route following the killing by the Nato forces of Pakistani soldiers in an unprovoked attack on military check-post near Afghan border  Officials capital flows dried up and foreign direct investment dropped to $810mn from $5.4bn in 2007/08. Consequently, the balance of payment situation deteriorated, showing a deficit of $3.28bn from a surplus of $2.49bn in 2010/11. This brought pressure on the rupee, which lost nine per cent against the dollar during last fiscal.

The government was forced to borrow heavily from the banks to finance its budget because of falling domestic tax revenues and drying foreign budgetary support funds after the premature termination of its $11.3bn loan facility from the IMF.

The government’s increasing reliance on domestic borrowings and runaway double-digit inflation forced the central bank to keep a tight leash on interest rates after cutting its key discount rate by 150bps in July 2011 to 12.5 per cent.

Tight and expensive credit coupled with long power and gas cuts for the industry dampened fresh investment spending, which has contracted by an average 9.3 per cent a year since 2009/10.

Some argue that the government’s lack of focus on economic revival and not political instability is responsible for its political problems as well as for increasing political and economic uncertainty in the country over the last four years.

“It is wrong to say that political instability has kept the incumbent government from formulating sound economic policies, implement financial reforms and turn the economy around,” argues a leading Lahore based businessman.

“The government had a good opportunity to make policies to remove energy shortages for the industry, reduce cost of credit for the business and plug leakages of scarce resources by restructuring public sector entities. I’d say its failure to focus on revival of public and private investment in the economy has contributed significantly to political instability and negative (economic) outlook of the country.”

Others say political stability and economic growth are deeply inter-connected. “The economy cannot grow in an uncertain political environment. You got to have at least a minimum level of political certainty to boost private investment, create jobs and increase production,” says another businessman, considered close to the PPP.

Contending that all the key players — politicians, judiciary and military — have made “mistakes” and contributed to increasing political instability and consequent economic downturn in the last four years, he says: “All is not lost. We can still recover from the current morass provided all the key players realize the implications of their actions for the economy and the people, and agree to put aside their differences and egos to work jointly for economic revival now. Otherwise, we all know where we are headed to.”