The balance of payments outlook

In response to questions by journalists about the costs and benefits of entering into a new loan arrangement with the IMF, the finance minister rightly pointed out that the country would have defaulted on its external debt repayments without such an arrangement. The economic, social and political consequences of external debt default are so horrendous that a responsible government should do everything to avoid such an eventuality.

The foreign exchange reserves of the State Bank of Pakistan (SBP) had dwindled down to about $5.2 billion by the end of July, 2013 and repayments due to be made to the IMF alone were of the order of over $4 billion in the remainder of the calendar year 2013 and in 2014. The net position of the financial account of the balance of payments had also turned negative implying that further draw down of reserves would have been needed to repay foreign debts other than that of the IMF.

In addition, the current account was running a deficit of about $2 billion on an annual basis. There is, therefore, no doubt that Pakistan needed a plan to finance its current account deficit, meet its external debt payment obligations and reverse the trend in foreign exchange reserves in FY14. The sensible short-term solution was of course to negotiate a bailout package with the IMF, which the present government did without wasting time.

The IMF programme is anchored on building up the gross reserves of the SBP to $9.6 billion by June 30, 2014, after financing the trade deficit, and meeting debt-servicing liabilities and foreign debt repayment obligations. The quarterly projections show that the gross reserves of the SBP will go up to $7.2 billion at the end of March, 2014 and further to $ 9.6 billion at the end of June, 2014. These are very ambitious targets.

It may be made clear that net inflows from the IMF will play no part in boosting foreign exchange reserves. In fact, on a net basis, the IMF would need to be paid back about $911 million during FY14 even if all the quarterly IMF disbursements under the EFF are made on time. The above targets of gross reserves of the SBP for FY14 are, therefore, predicated on an improvement in the current account of the balance of payments and certain key assumptions about inflows from various sources other than the IMF.

The current account deficit is assumed to show an improvement of $981 million in FY14 as compared to FY13 reflecting mainly an increase of 11 percent in exports, a very moderate increase of four percent in the cost of oil imports and some increase in home remittances in FY14. In addition, there is a projection of a net inflow of $3.9 billion in the financial account of the balance of payments in FY14 compared with a net outflow of $90 million in FY13. This improvement is expected to take place under three main heads.

Direct foreign investment is expected to increase to $2.3 billion in FY14 from $1.5 billion in FY13. It includes privatisation proceeds in foreign exchange of $800 million. Moreover, disbursement of foreign loans, other than that from the IMF, is to increase by about $1.4 billion from $2.1 billion in FY13 to $3.5 billion in FY14.

Some of the policy assumptions for projections relating to the current account outcome are worth noting. A substantial expansion of exports in foreign exchange terms would crucially depend on generation of exportable surplus and increased price competitiveness of exports. With the growth rate expected to actually decline to 2.5 percent in FY14, generation of exportable surplus would depend on some switch from domestic consumption to exports through appropriate policy measures. With the domestic rate of inflation projected to go up to double digit again in FY14, it would require a substantial depreciation of the exchange rate.

Indeed the IMF has an explicit projection of depreciation of the real effective exchange rate of 7.7 percent built into its programme for FY14. It contradicts the finance minister’s claim that there was no discussion with the IMF on the depreciation of the nominal exchange rate. One thing or the other will have to give in. Either the projected improvement in exports will not take place or the exchange rate would have to be allowed to depreciate as assumed by the IMF.

The assumption of inflow of foreign investment can materialise only if, in addition to the structural issues relating to the energy sector and regulations, the law and order and external security situation improves and there is a clear policy enunciated to attract foreign investment in the country. The availability of coalition support funds of $1.2 billion assumed under the programme is not strictly under the control of the government but the IMF must have confirmed their likely release from the US sources. The assumed increase in the net loan disbursement by other multilateral institutions and bilateral sources is likely to materialize if the EFF arrangement with the IMF remains operational because those are usually tied up with an operational IMF program.

Even if the reserve buildup targets set up for FY14 may not be fully achieved because of various likely shortfalls, there is no doubt that the imminent threat of external debt default and disruption in foreign trade have been avoided.

In the past, standby and other arrangements with the IMF were used by governments to delay the difficult economic policy decisions rather than to facilitate them, which landed the country in the current structural economic difficulties. It is important, therefore, that this window of opportunity is used by the present government to take structural reform measures to impart long-term stability to balance of payments and the economy.

But the IMF programme does not have really meaningful structural reforms in it – and it is indeed puzzling that the IMF has not incorporated important structural reform measures in the current EFF arrangement even as compared to the previous aborted standby arrangement.

An economic strategy of increasing exports and controlling the rising trend of imports and external debt servicing, gradually reducing the stock of external debt at least as a percentage of the GDP and making the balance of payments self-sustaining without recurring short term bailout packages would require more than what is included in the IMF programme.

There is a need to reduce the trade deficit from the high level of about $15 billion annually to a more manageable level and to contain the rising deficit on the services account due to a rising level of external debt servicing. These moves, in combination with measures to attract high level of home remittances, could ultimately create a current account surplus that could be used to build up the cushion of foreign exchange reserves on a durable basis, assuming that the financial account would ultimately become balanced on a net basis.

The latter is necessary if the government is serious about breaking the begging bowl. It is also important to understand that we need to undertake structural reforms not to meet the IMF conditionality but to set the economy on the right path.

The major reform measures that need to be undertaken in this regard are well known by now: increasing the domestic rate of saving and investment; reorienting development policies towards export-led economic growth; reducing the budget deficit on a durable basis by expanding the tax base and extending it to services and agricultural sectors, limiting the growth of current expenditure and on prestige projects; removing price subsidies; privatising the loss-making public sector enterprises; increasing public sector accountability to reduce inefficiency and corruption; and slowing down the rate of monetary expansion and bringing down the rate of inflation.

This is a tall order requiring a massive economic policy restructuring extended over a number of years affecting all segments of the society and all sectors of the economy – and it needs to be done not to satisfy the IMF but to save the economy.

The writer is a former governor of the State Bank of Pakistan.Email: doctoryaqub@hotmail.com