Pakistan comes knocking to IMF

The IMF is expecting the external financing needs of Pakistan around 7.5 percent of GDP in the medium terms. The question is that who would fund that gap? Would it be multilaterals led by the IMF or CPEC and international debt market would be enough to plug the hole?

These are tough questions; but one thing is for sure that the foreign exchange earnings would remain low and FDI would be too less to fill in the current account deficit. The IMF projects the current account deficit to be $10.1 billion in FY18 and $11.6 billion in FY19. The SBP reserves stood at $16.1 billion at the end of FY17.

The reserves are down by $2 billion in FY17 while the CAD is expected to be around $11.5 billion in FY17. The FDI plugged in $2.4 billion and adjusted for portfolio investment, the net inflows are reduced to $2.2 billion. Rest is primarily debt in one form or the other. The debt increase in 9MFY17 stood at $3.7 billion.

Debt related flows are primarily coming from China (under CPEC) and other bilateral, multilateral flows from ADB, WB etc, and bonds/sukkuk from global debt market. The question is that how long the debt flows would keep on coming. History suggests that till the country has clean chit from the IMF, other multilaterals will keep on releasing money to not let the foreign exchange reserves to fall to critical levels.

Now the language in its latest country report is implying that the fund is not happy with the proceedings and is deeming that the stability gain might fast erode. One may wonder what is the shift in the economic policies in the last six months which has compelled the fund to significantly alter its stance from rosy to thorny.

Weren’t exports falling six months ago? Was the FDI not hard to come by then? Were imports too low a few months back? The trend is visible throughout this growth momentum that debt is fueling the growth in Pakistan. Higher the economic growth, higher is the import while exports cut a sorry figure.

There is no doubt the growth is broad based, momentum is there, and the economy will continue to grow around 5 percent till the macroeconomic stability is intact. The growth is linked to the confidence and anything that breaks the confidence would be detrimental for growth thesis, such as going back to an IMF programme.

History suggests that whenever Pakistan enters a fund program, growth suffers (see graph). First we need to understand what is fueling latest episode of growth. The fiscal spending is driving the momentum (read: "Government dominated investment" published on June 20, 2017) along with CPEC related investments and flurry of money from donor and multilateral agencies. The feel good factor is there and to see the expansion in infrastructure, many private sector companies in the businesses are in expansionary phase. And the rest of the growth is due to the rising middle class consumerism.

However, both government led growth policies and confidence can erode once the external vulnerabilities reach alarming levels. If the government reenters the fund program in 2018-19, the fund would ask for both fiscal austerity and monetary tightening. Not to mention the currency adjustment would be a prerequisite to entering an IMF programme.

And once the country is back into the IMF programme, the likes of WB and ADB would ask for the letter of comfort from the IMF before releasing their respective promised flows. That is what happened in the past and could well be the case in future. Why are the ADB and WB so inclined to spend money in Pakistan for past eighteen months? Because, the country still has a green signal from the fund. Now the situation may change, if the latest IMF country report is any guide, the fund may soon start tightening the screws.

The global debt capital market would no more be welcoming for Pakistan if the above mentioned scenario becomes a reality. The yields on Euro bonds trading in international market are already heading south due to political weakening.

Can we rely on China to avert a balance of payment crisis? Well, not really, as China has to date given only $500 million to $1 billion for balance of payment support, and seeing the growing size of economy and CAD, the need is greater. What is the alternate for an IMF programme? Probably none.