The IMF targets

The IMF has just released the report on the fourth and fifth review of the EFF with Pakistan. This review also contains projections of the economic outcome in 2014-15. As demonstrated below, the projections are optimistic in nature and do not adequately reflect the conditions both in the global and the domestic economy. Clearly the Fund has an interest in showing positive developments to demonstrate that the Program is working successfully.
The GDP growth rate is projected at 4.3% in 2014-15, as compared to 4.1% in 2013-14. The Fund does recognise that the latter growth rate has been significantly overstated. Is there a basis for assuming that the economy will grow faster in 2014-15?
First, the large-scale manufacturing (LSM) sector is in the grip of a slowdown. In the first four months, July to October, the growth rate is very low, at below 2%. This is a reflection of the fall in exports, pervasive gas shortage and power load shedding. To get back to the growth rate last year of 4%, the sector will have to grow at a faster rate of 5% for the remainder of the year. This is unlikely.
Second, the agricultural sector has been impacted by the floods, albeit less than what was thought to be case initially. It is estimated that there is a modest increase in the output of the cotton and sugarcane crops. However, rice production has declined significantly. The expectations are that there will be a significant jump in the output of wheat crop of about 4%. Overall, the major crop sector is likely to show a somewhat higher growth rate of about 2%, as compared to only 1% achieved last year. With the primary and secondary sectors showing slow growth it is unlikely that the tertiary sector of services will be buoyant. Overall, 2014-15 is likely to close with a growth rate of GDP between 3.5 to 4%.
The IMF projects a major revival of investment in the economy with a growth rate of 16% in 2014-15. Private sector investment, in particular, is expected to be very dynamic, with a growth rate of over 21%. Unfortunately, these are very optimistic projections. In the first five months, imports of machinery have increased by 6%. Bank credit to the private sector is down by as much as 56%. Further, releases for the federal PSDP show little real growth over the level attained last year. Foreign investment has shown some growth, but is down to less than 5% of the total investment in the economy. If security conditions deteriorate then private investment may become more shy.
One area in which the IMF appears to be unduly cautious is in the projection of the rate of inflation, at just under 8% in 2014-15. Already, it has fallen to 4% in November 2014. Part of this is, of course, due to the 'high base' effect, with inflation at the peak rate of almost 11% in November 2013.There is no doubt, however, that sharply falling commodity prices internationally are exerting a strong downward pressure on the domestic price level. The Government has appropriately brought down the prices of petroleum products and has indicated that it will do the same with electricity tariffs.
However, there are reasons why the rate of inflation may start rising somewhat from 4% once again. The procurement/support prices of wheat and sugarcane have been raised. An increase in gas prices may be in the offing. Also, oil prices internationally may have bottomed out and may start rising later in 2014-15. Over all, the IMF expectation of average inflation in 2014-15 of almost 8% is on the high side. It is more likely to be in the range of 6 to 6.5%.
Turning to the projected size of the fiscal deficit, both the government and the IMF are expecting a low deficit of 4.8% of the GDP in 2014-15. The actual deficit may be substantially larger for a number of reasons. First, FBR revenues are already falling short of the target significantly. Second, the inability to levy the Gas Infrastructure Development Cess (GIDC) may lead to a loss of almost Rs 140 billion. Third, there may be no option, sooner or later, but to retire most of the circular debt of almost Rs 300 billion. After allowing for a cutback of over 15% in the national PSDP, the consolidated deficit of the federal and provincial governments may approach 6% of the GDP.
The trend in the balance of payments is of crucial importance. The IMF is very positive about the build-up of foreign exchange reserves to $14 billion by the end of 2014-15. This will represent an increase of $5 billion over last year's level. The current account deficit is expected to rise to $4 billion, from just under $3 billion in 2013-14. This will be compensated for by a jump in capital inflows, especially due to an increase in the net inflow from the IMF under the EFF.
In line with the fall in commodity prices, the Fund expects exports to rise by only 1% in 2014-15. However, exports have actually fallen by 2% in the first five months. They are unlikely to show a big positive growth rate in coming months. Imports are projected to grow by 5% in 2014-15, as compared to 6% from July to November. The growth rate may be lower as the country benefits from lower prices. Overall, the Fund projection of a current account deficit of $4 billion looks reasonable.
The problem is with the expected magnitude of capital inflows. The biggest risk is that foreign portfolio investment may turn negative in coming months as Pakistan fights the war on terror with much greater intensity and there is some blow-back. The IMF projection of net portfolio investment of $1.2 billion, excluding the Ijara Sukuk bond flotation, is likely to be missed by a wide margin. In fact, some repatriation of capital from the stock market has already started.
Given the higher risks to the balance of payments, including the possibility of some recovery in oil prices, a continued rise in foreign exchange reserves through the year can be considered a positive outcome. While the projected level of foreign exchange reserves of $14 billion by the end of 2014-15 looks unattainable, a good outcome will be if reserves reach $12 billion.
In summary, the year 2014-15 may not see the kind of strong revival and greater stabilisation of the economy as anticipated by the government at the start of the year in the Annual Plan and more recently by the IMF. The growth rate of the economy may show little improvement, private investment will remain shy, the fiscal deficit could rise sharply and the balance of payments position may not improve substantially. The silver lining could be a sharp fall in the rate of inflation.
(The writer is the Managing Director of the Institute for Policy Reforms (IPR) and a former Federal Minister)