The first review report prepared by the IMF staff became available in late-December 2019. This followed the successful completion by Pakistan of this review. All the performance criteria were met. This has improved perceptions about the extent of success on the stabilisation front. The second tranche of the IMF loan has also been released.
The IMF staff had first released a report on the 8th of July after the formal request by the Pakistani authorities for the Extended Fund Facility of $6 billion. This report had reviewed the economic situation, identified the key structural reforms and specified the quarterly performance criteria and indicative targets for 2019-20, the first year of the Programme. In addition, detailed macroeconomic projections, including the balance of payments and public finances, were made for the duration of the Program from 2019-20 to 2021-22.
The first review report contains modified projections in light of developments on the economic front in the first six months of 2019-20. The objective of this article is to assess the validity of these projections first for 2019-20. Projections for the next two years of the Program, 2020-21 and 2021-22 will be discussed in the next article.
The projected GDP growth rate for 2019-20 has remained unchanged at 2.4 percent. This will be the lowest growth rate since 2008-09 and highlights the strong negative impact of the stabilization process on economic growth. IMF's growth projections are based primarily on developments on the demand side.
The level of investment is expected to fall from 15.4 percent in 2018-19 to 14.5 percent, implying a decline in real terms of almost 5 percent in 2019-20. However, private investment, as measured by the level of import of machinery, has declined by more than 14 percent in the first six months, according to the SBP. Clearly, the hike in interest rates has had a stronger negative impact.
The IMF rightly expects the over 15 percent reduction in the net trade deficit in goods and services to have a significant positive impact on GDP growth. However, this is likely to be at least partially neutralized by the bigger fall in private investment, a faster increase in indirect tax revenues and limited growth in defense spending.
The developments on the supply side of the economy paint a gloomy picture. The Quantum Index of Manufacturing has declined by 6 percent in the first five months of 2019-20. The cotton crop output has fallen by over 15 percent and the sugarcane crop is also likely to be smaller. The largest sector of the economy, wholesale and retail trade, is experiencing a contraction. The consumption of POL products has fallen by 7 percent, implying a decline in transport activity. Cement consumption has increased by less than 1 percent implying hardly any growth in the construction sector up to November.
Overall, there are strong indications from the supply-side that the growth process has severely faltered. The likelihood is that the growth rate of the GDP is unlikely to exceed 2 percent in 2019-20. The somewhat more positive picture on the demand side as highlighted by the IMF is likely to imply that the residual, private consumption will show little or no growth in 2019-20. Of course, the PBS has been systematically exaggerating the GDP growth rate over the last five years. This may happen again in 2019-20.
Turning to the rate of inflation in the Consumer Price Index (CPI) the First Review Report has brought down the projection from 13 percent to 11.8 percent. Apparently, the primary reason for this is that with the big reduction in the current account deficit, the exchange rate projection for 2019-20 has been brought down by almost 6 percent and this will imply less imported inflation.
The average monthly rate of inflation on a year-to-year basis up to January has been 11.6 percent, rising steadily from 8.4 percent in July 2019 to 14.6 percent in January 2020. For the inflation rate to average 11.8 percent for the year, as per the IMF, the average rate of inflation in the next five months will have to be significantly lower at 12.1 percent. The expectation, therefore, is that there will be a significant decline from the rate of 14.6 percent in January 2020.
However, there are strong reasons for the inflation to remain higher in the immediate short-run. The prices of some basic food items like atta and sugar have skyrocketed recently and this alone could raise the inflation rate. Further, PBS has tended to substantially under estimate the rate of inflation. The big under statement is in the rise in housing rents at below 6 percent. Given the growing housing shortage, the rate of increase in rents has generally exceeded the overall rate of inflation since 2012-13. Overall, the underlying rate of inflation in January 2020 was closer to 16 percent, significantly higher than the rate reported by the PBS of 14.6 percent.
The projected rate of inflation by the IMF staff is on the lower side because of the downward bias in the rate reported by the PBS. Also, it is likely to continue rising in the face of higher inflation in food prices. Therefore, an unbiased estimate of the average monthly rate of inflation in 2019-20 is 14 percent.
The next set of key variables relate to the current account deficit in the balance of payments. There was more optimism earlier about the growth in exports in response to the substantial depreciation of the rupee. The original expectation by the IMF in July was that exports would increase by over 8 percent in 2019-20. The latest projection has revised it downwards to 6 percent. However, exports have registered growth of only 4.5 percent. Hopefully, there will be a minor upsurge and annual growth of 6 percent will be achieved.
The real uncertainty relates to the growth of imports in the second half of 2019-20. They have plummeted by an unanticipated 21 percent in the first six months. The original IMF projection was a 5 percent decline in imports. Given the much larger fall, the projected level has been brought down by over 2 percent for 2019-20. However, the revised projection still implies that imports will grow by 11.5 percent from January to June 2020.
There are reasons why imports could start rising once again. First, the devastating failure of the cotton crop will necessitate over 5 million bales of imports, costing almost $2.5 billion. This will certainly add to the import bill. Also, there could be a catching-up process in POL imports. They have declined by as much as 34 percent, possibly due partly at least to deferment of oil import payments. Domestic consumption has fallen much less by 7 percent. Overall, the anticipated positive growth in imports in the second half of 2019-20 by IMF is a plausible scenario.
Therefore, the likelihood is that the current account deficit will be substantially higher in the second half of the year. IMF expects it to be $4.4 billion, virtually double the deficit from July to December. There is, therefore, no ground for complacency. With higher debt repayments simultaneously with a larger current account deficit, there could be greater pressure on foreign exchange reserves in coming months.
The final critical area in the macroeconomic scenario is the projected state of public finances. Here, there are serious disagreements with the latest IMF projections for 2019-20, despite changes in light of trends in the first half of the year.
The first issue relates to the projected growth in FBR revenues. The revised projection does reduce the FBR revenue target by Rs 295 billion, probably because of the lower base year magnitude of 2018-19. However, given the actual increase of 16 percent in the first six months, even the lowered annual revenue projection will require a growth rate in FBR revenues of 54 percent from January to June 2020. Further, non-tax revenues have been scaled up by Rs 332 billion. These are both beyond the realm of possibilities. Therefore, even if the growth rate of revenues rises somewhat, expenditures are curtailed or a mini budget is pushed for by the IMF, the budget deficit is likely to be larger by almost 650 billion, equivalent to 1.5 percent of the GDP.
The IMF has already partly anticipated this and raised the budget deficit projection from 7.1 percent to 7.5 percent of the GDP. But it could be significantly larger and approach 9 percent of the GDP, even higher than the peak level attained in 2018-19. This will imply that the primary deficit will be 2.1 percent as opposed to the target of 0.6 percent of the GDP. Pakistan is likely to have a serious problem in meeting the performance criteria related to ceiling to the size of the primary deficit from the third review onwards.
In summary, the IMF projections made in December for 2019-20 and expectations regarding the likely outcome are presented below. The changes are mixed in nature with improvement in some and deterioration in others.
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PROJECTIONS FOR 2019-20
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IMF IMF Likely
Earlier Latest
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GDP Growth Rate - (%) 2.4 2.4 2.0*
Rate of Investment (% of GDP) 14.7 14.5 14.0
Rate of Inflation (%) 13.0 11.8 14.0
Growth Rate of Exports (%) 8.2 5.8 5.8
Growth Rate of Imports (%) -4.8 -6.7 -6.7
Current Account Deficit (billion$) -6.6 -6.6 -6.6
Tax to GDP Ratio (%) 14.2 13.7 11.9
Budget Deficit (% of GDP) -7.1 -7.5 -9.0
Primary Deficit (% of GDP) -0.6 -0.6 -2.1
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*Subject to no bias in reporting by the PBS
(The writer is Professor Emeritus at BNU and former Federal Minister)
The writer is Professor Emeritus at BNU and former Federal Minister
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