Macroeconomic (in)stability

The macroeconomic stability achieved in the last two years or so has been challenged lately. The twin deficit that had jolted the economy in 2008 is surfacing again to test the post 2014 economic recovery. But both current account and fiscal account deficits are slipping and are bound to increase, the way they are being mis(managed).

General elections are in 2018; and government may well run expansionary fiscal and monetary policies and there will be no compromise on energy provision from whatever available sources. That is a recipe of crisis for a country that has historically faced number of balance of payment crisis, fiscal slippages, and circular debt problems.

There are number of energy projects coming up, a few are under CPEC and other are government-owned RLNG plants. Efforts are underway to have them operational prior to the elections. With the inclusion of coal, RLNG, nuclear and hydel projects, the capacity burden would increase substantially. This may compel authorities to increase the base tariff.

And it is likely that expansive RLNG projects may take priority and this would test the import bill. The oil prices have crossed fifty dollars and the current account is already in pressure. This will mount further in upcoming summers. The government has to take tough decisions on whether to have more load shedding or higher energy related import bill.

The circular debt is already pinching IPPs as a few have invoked sovereign guarantees. With new plants coming up and prices likely to go further up, the circular debt may resurface with all its might.

If the government keeps on clearing dues of IPPs, the fiscal deficit increases, or else power load shedding soars. It will be a catch 22 situation for the government this summer. The problem of fiscal deficit and its financing would be an issue as the target of 3.8 percent of GDP for FY17 is elusive, given that deficit has reached 2.80 percent of GDP in the first six months.

The tax revenue growth in the first eight months is at 8 percent against the yearly target of over 16 percent. While in case of non tax revenues, the picture is bleaker. There is no CSF release, nothing on 3G/4G and privatization proceeds. In case of expenditure, development spending ought to increase disproportionately prior to the elections. The provinces may tend to not show high surpluses, as spending would sour in federating units as well.

Fiscal financing burden has to fall more and more on domestic sources and Dar is eyeing SBP financing, which is inflationary in nature. Unless, government finds external sources to finance, inflation is bound to jump in a years time. If the external financing is available, it will put pressure on external account in coming years, once repayment starts.

The external account vulnerabilities are already visible and are haunting the economic recovery thesis. The current account deficit in the last few months is approaching the 2008 levels. The import bill is bound to increase further given that machinery imports would remain high. The soaring energy related import bill story has already been spoken of.

The exports keep on cutting a sorry figure, while remittances are saturating. The government is trying to curb imports through imposing 100 percent cash margins for number of consumer items including automobiles. The support to export is coming in the form of a package announced by the PM a couple of months ago. The impact of exports cash rebates ought to come on numbers; but it is not likely to be much and it comes with some fiscal cost. While curb on imports through cash margins may increase the cost of imports and its impact would not be significant.

Thus the current account will slip further and there is not much in capital and financial accounts anticipated flows to support it. The FDI is on the lower side and there are no IMF flows to support foreign reserves growth. The repayments of foreign loans are going to be high in 2017-18 and that would put further pressure on balance of payment. Either the government replaces these with fresh loans or let the reserves to fall. The former is likely, as government would like to keep reserves high, prior to elections 2018.

One inherit policy tool to tame external deficit is to let the currency finds its equilibrium. Right now it is based on real effective exchange rates, appreciated by 20-25 percent. Sooner or later, the currency will find its real value. Delaying the inevitable will only worsen the problem. Chances are that the bubble will burst when the interim government is in the office. Watch out!