Rising debt servicing emerges as hindrance: Projection of cut in C/A deficit subject to certain risks

ISLAMABAD: The government projection of a reduction in the current account deficit to US$ 3.7 billion is subject to certain risks and the challenge of rising debt servicing could hinder the reduction of the fiscal deficit.

This was stated by Finance Ministry in its fiscal risk statement for fiscal year 2023-24 released on Thursday noted that a more significant than expected slowdown in global demand could have a negative impact on Pakistan’s export outlook and workers’ remittances.

Global and domestic uncertainty also poses a downside risk to this forecast. On the upside, a larger than anticipated slowdown in domestic demand or a relatively sharp fall in global commodity prices could improve the current account deficit and reduce fiscal risk.

July C/A deficit stands at $809m

The inflation outlook has deteriorated, and there is heightened risk to external stability. The uncertainty surrounding the future adjustment path in energy prices is the main upside risk to the inflation outlook.

However, a potential moderation in international commodity prices may contribute to a reduction in inflation.

During the first half of the current fiscal year, there was a noticeable decline in average international oil prices, which is expected to continue soon amid concerns of a global recession.

The government has forecasted a reduction in the current account deficit to US$ 3.7 billion in fiscal year 2023, which appears feasible. However, this projection is subject to certain risks.

The government wanted to reduce the fiscal deficit by implementing measures such as expanding the tax net, rationalising subsidies, and promoting economic growth. However, the challenge of rising debt servicing could hinder the reduction of the fiscal deficit.

Three scenarios (depicting macroeconomic risks) are simulated to analyse fiscal risks. The scenario-I projects/simulates the reactions of revenues, expenditures, and fiscal deficit in a situation where government can have access to low-cost availability of financing options (reduction of two percentage points of interest rate on external debt and four percentage points in domestic currency interest rate).

The net federal revenues are expected to remain at 6.7 per cent of GDP, federal expenditures will eventually reach 9.7 per cent of GDP, whereas, federal fiscal deficit will touch three per cent of GDP.

The scenario 2 elaborates the responses of revenues, expenditures, and fiscal deficit to reduction of 50 per cent in non-tax revenues against baseline projections.

The net federal revenues will decrease to 5.3 per cent of GDP, federal expenditures will remain at 10.6 per cent of GDP, and federal fiscal deficit will increase to 5.4 per cent of GDP.

The scenario 3 highlights the reactions of revenues, expenditures, and federal fiscal deficit, if growth rate remains below the projected rate by 0.5 per cent every year in the medium term.

By FY2026, the net federal revenues, federal expenditures, and federal fiscal deficit will remain at 7.1 per cent, 11.0 per cent, and 3.9 per cent respectively. Federal fiscal deficit is more sensitive to low non-tax revenue collections than decrease in interest payments or GDP.

The government has initiated several policy reforms to restore fiscal discipline and debt sustainability, safeguard monetary and financial stability, and maintain a market determined exchange rate (to rebuild foreign currency reserves).

Total public debt (TPD) is a measure of government indebtedness – debt of the government (including the federal government and the provincial governments) serviced out of the consolidated fund and debt owed to the IMF.

External debt constitutes 40.8 per cent of total public debt, which may make the government’s fiscal position vulnerable in the face of high current account deficits, low foreign exchange reserves, and a weakening exchange rate.

A lack of foreign exchange reserves coupled with large external payments has resulted in liquidity issues and destabilized the exchange rate and domestic interest rates, further increasing the burden of external loans that are measured in local currency.

Ongoing fiscal deficits require refinancing of the government’s maturing debt while raising additional debt to fulfill the fiscal shortfall. A high level of short-term debt creates potentially significant refinancing challenges during periods of slower economic growth, higher fiscal deficits, and/or lower investor confidence.

Therefore, to manage the refinancing risk, it is important for the government to achieve and maintain a longer average time to maturity of its domestic as well as external debt.

The government has borrowed significant amounts in recent years by utilising commercial sources such as medium to long-term Eurobonds and short-term bank loans resulting in decline in average time to maturity of external debt.

Pakistan’s state-owned enterprises (SOEs)’ ongoing financial and operational performance is a considerable source of fiscal risk.

Copyright Business Recorder, 2023