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How this govt helped country avert sovereign default

In April of this year, when Mian Shehbaz Sharif became prime minister and appointed me as finance minister, Pakistan had about $10.5 in foreign exchange reserves. Our reserves had fallen by $7 billion since February and were depleting at an unsustainably fast pace.

Our imports were breaking all past records and in the fiscal year increased to $80 billion. Against exports of $31 billion and remittance of $30 billion, these record high imports led to the third highest current account deficit at 5% of GDP or $17.5 billion. (The highest current account deficit of 8.1% of GDP ($11.7 billion) was in 2007/08 and second highest of 6% of GDP was in 2017/18 ($19 billion).

As we planned for the next fiscal year, the prime minister and I were looking at foreign exchange needs of $24 billion for debt repayment and at least $12 billion to finance the current account between April 22 and June 2023. We were also mindful of what was happening in Sri Lanka which had just defaulted. Our economy too was in an acute danger of default. In fact, Bloomberg had reported Pakistan to be the fourth likeliest country to default.

In December of 2021, when the PTI government had revived Pakistan’s IMF programme post the Covid relaxation, it had agreed with the Fund that it will run a primary deficit – that is, total deficit of Rs 25 billion for the year. Yet four months later when I joined the government, I was informed that we were going at a pace of Rs 1300 billion for the primary deficit, an outcome 5200 percent worse than PTI’s commitment. We were going to make a record budget deficit of over Rs 5000 billion, indicating that our domestic fiscal situation too was getting unsustainable.

The PTI government had also agreed with the Fund to increase petroleum levy by Rs 4 every month until it reached Rs 30 per litre and to increase sales tax by 2% every month until it reached 17%. But in February, Imran Khan unilaterally decided to withdraw all taxes and indeed started subsidising petrol and diesel. At one point the government was losing Rs 80 per litre on diesel and Rs 40 per litre on petrol. We were selling petrol cheaper than the UAE and diesel cheaper than both Saudi Arabia and the UAE. Since a billion litres of each fuel was being consumed (and hoarded) every month, our losses reached as high as Rs 120 billion per month. This was more than our defence expenditures, more than twice our development expenditures and more than three times the cost of running the entire civilian federal government. This large subsidy was unique in the world and in our history. And it was suicidal.

Pakistan’s default risk had gone so high that fresh commercial borrowing or issuance of bonds had become an impossibility. When a country doesn’t have enough foreign exchange to cover three months of imports, and it’s not in an IMF programme, then no multilateral institution, such as the World Bank, lends to it. Even friendly countries were not willing to lend to us. They did however advise us to restart our IMF programme and helped us achieve it. (The only exception was China which had withdrawn its loan of $2.3 billion in March but lent back to us in June but only after PM Shehbaz Sharif’s personal intervention).

At that point we were burning through $3 billion in foreign exchange due to repayments and financing of the current account. Without that lender-of-the-last-resort IMF and substantial belt tightening, June or July was the limit of our solvency. We had to act resolutely and raise the prices of fuel, power and gas.

For me, the prime minister and most of our cabinet colleagues the choice was obvious. The Pakistani economy was in imminent danger of default and this was no time for politics as usual. For most of us personal ambition and political calculus took a back seat to the interest of the state. For most of us, but not all of us. I was relentlessly criticised for making hard choices by many analysts and politicians who refused to believe that Pakistan was in grave danger of default and we had no margin for error.

At budget time to bring the deficit under control we had to raise new taxes. It would’ve been easy for us to raise sales tax by 1% and put that burden on consumers. But we chose to tax the richest Pakistanis more. To his credit the prime minister was quite pleased when I imposed ten percent extra tax on sugar mills – two of which are owned by his sons.

To add to our challenges, our power sector was a complete mess. Pakistan was importing costly furnace oil, diesel and LNG and using them to make very expensive power. Then distributing that power in a most inefficient and theft-prone manner. And finally, failing to collect enough bills. The money being bled by the power ministry was enough to destroy our economy. PTI had increased power-sector circular debt from Rs 1100 billion to Rs 2400 billion and introduced gas sector circular debt, which is Rs 1300 billion.

In addition, many energy sector companies are essentially bankrupt.

When we assumed the government, power plants of 7500MW capacity were shut down either due to maintenance issues or not having money to buy fuel. We had to fix those issues and restart all the plants as May was one of the hottest months and demand for electricity reached as high as 31000MWh. Even with every power plant available in Pakistan, including the most inefficient furnace oil plants (which had fuel cost of Rs 59 per unit), we could only produce about 25,000MWs. The people rightly complained of load shedding but when they were sent those high electric bills in August – the cost of fuel used in May is submitted to Nepra in June and is approved in July and sent to consumers in the July/August billing cycle—they again rightly complained.

I say rightly complained because in a properly functioning state, citizens deserve continuous supply of electricity at a reasonable rate. But given the inefficient transmission and distribution system in Pakistan, the theft, the expensive fuels and the fact that the outgoing PTI government had neither improved the efficiency nor raised base power tariffs since February 2021 while fuel cost had doubled meant that the cost of producing and distributing electricity had become exorbitant.

The government was caught in a dilemma. If we saved money in May we would leave our industry and citizens without electricity in the hot weather. And if we produced power in May the bills in July and August would be exorbitant. We weren’t going to fix the system in a few weeks and we had agreed with international financial institutions to not increase circular debt and risk the entire system collapsing.

There was a huge and justifiable outcry when August electric bills were received by consumers. I was in Qatar when the PM called me and asked me to find a way to give middle- and low-income consumers a break from those bills. I spoke to the power ministry and our development partners and came up with a plan to defer the fuel adjustment part of the bills for the low-income consumers only. The PM wanted these waived off completely but I requested him to only defer it and waive it only when we found room in the budget. The PM and I had a fundamental understanding that before we do any additional expenditures or give any tax break, we will find fiscal space. We were not going to increase our unfunded expenditures and deficits as past governments had done and which had kept Pakistan going to the IMF repeatedly. We were going to run Pakistan with greater fiscal responsibility than had been hitherto done.

This is the same reason we temporarily put in semi-formal import restrictions. The idea was for Pakistan to live within its means. The State Bank’s margin requirements were only benefiting banks, raising costs and weren’t working. Restrictions that I had suggested to them however were curbing imports. But such restrictions create a lot of disruption in the economy and can only be used for a short period.

By mid-August, our rupee had organically recovered to 213 against the dollar from 240 and the IMF program had been streamlined. Our large oil LCs were easily being confirmed by foreign banks without my intervention and the talk of Pakistan’s default internationally had died down. Even our 2022 bonds were trading at 96% of the face value. But then we raised petrol prices and there was a public disagreement about it. This created uncertainty in the forex and stock markets. And then the floods happened.

Mian Shehbaz, whose heart is in the right place, wanted to give Rs 50,000 to each of the 4 million families affected by the floods. I could only manage Rs 25,000. This still meant Rs 70 billion but the prudent businessman in me had kept money in the budget for just such a natural calamity. In addition, we gave considerable funds to NDMA for food rations, tents, mosquito nets, logistics, etc.

In spite of the huge flood loss, we had done enough to ensure Pakistan would be able to weather this devastation. We were trying to create export bias in Pakistan to reach $35 billion of exports and less than $70 billion in imports this year.

Mian Shehbaz Sharif knew even before he became prime minister that he would have to make seriously hard choices. The choice before him was clear: save Pakistan from default or worry about his political capital. He made the right choice. And even as I have been removed as minister, I hope and expect that he will continue to make the right choice. This is not a favour to this nation. This is what all of us owe our homeland.

Miftah Ismail, "How this govt helped country avert sovereign default," Business recorder. 2022-10-11.
Keywords: Economics , Monetary fund , State Bank , World Bank , Mian Shehbaz Sharif , Pakistan , Sri Lanka , Saudi Arabia , China , NDMA , IMF , UAE , SBP , US

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