Macro stresses begin to surface

Signs of building macro stress have started to show, especially in the external account. Rising global commodity prices and a pickup in imports are contributing to the phenomenon. Although growing slippages in fiscal may be partially controlled by lowering development spending, inflationary pressures are likely to persist. This means that currency may remain under pressure. The silver lining is the strength shown by real economy, as productive sectors are bullish. Improved nominal growth may help tax revenues to grow.

Overall direction of the budget is right, as incentives have been offered for manufacturing base to grow. The focus is on export promotion. Many decisions are right. However, in some cases, revenue considerations are superseding broader wisdom. One example is removal of intercorporate dividend tax exemption, which may discourage corporatization and hurt sponsor groups who have created corporate culture. Then proposed taxes on basic food products or their raw materials – such as sales tax on dairy products and agriculture machinery are also misguided. These would further fuel food inflation. At the same time, strict compliance for non-taxpayers and plans to promote digitization at retail level will prove beneficial for the medium- to long-term.

In the backdrop of natural momentum and pro-business budget, real economic growth rate is likely to improve over the next fiscal year. The elephant in the room is management of external account slippages. Monthly imports may likely remain rangebound between $5.5 billion to $6 billion. External debt servicing pressure will grow in the absence of timely flows from multilaterals, the World Bank (WB) and Asian Development Bank (ADB). These flows are contingent upon the International Monetary Fund’s (IMF’s) nod. And IMF is worried about the viability of plans for generating budgeted tax and non-tax revenues.

IMF talks are stalled, which is not a first during the ongoing programme. IMF may want to see how budget numbers will materialize in the first quarter, as shortfalls are expected. However, higher commodity prices may result in higher tax collection at import stage and improved economic activities may help Federal Board of Revenue (FBR) achieve a decent growth. The catch lies in Petroleum Levy (PL). To achieve targeted collection of Rs610 billion, PL should be around Rs25-30 per liter, a far cry from current levels. The government must increase petroleum prices to pass on some of the impact to consumers. If that happens, IMF talks may resume sooner. Else, the delay could prove costly.

No political government fancies increasing petroleum prices; but as an oil importing country, Pakistan needs to protect its macro stability. The good thing is that the energy mix – especially in power generation - has improved, and the reliance is moving away from furnace oil to RLNG, coal, nuclear, and renewables, including hydel. Thus, compared to five years ago, the impact of higher oil prices will be lower.

However, the worrisome fact is growing coal and RLNG prices, which are increasing at a higher rate than oil prices. Pakistan imports close to 16 million tons of coal per annum, which is used in power sector and industries such as cement. Coal prices have almost doubled in less than a year, hovering at all-time high of $120 per ton. Annual import bill is likely to double to around $2 billion at current prices. This has created pressure on cement margins, leading to prices hikes. As coal is a pass-through item in power generation, the overall energy mix will become more expensive. It is no longer the cheapest of energy.

The other area is RLNG. Pakistan has the capacity to import 12 cargoes per month. Out of which seven are based on long-term contracts. The remaining five are imported at spot prices (if needed). Two months back, LNG prices were around $6-6.5/mmbtu (10 to 11 percent of Brent prices). Everyone in the market was expecting prices to move up. Cargoes for the next few months should have been booked at spot at that time.

Now, nine cargoes have been booked for July and August at an average of $10.98/mmbtu (15-17% of Brent). The opportunity loss to the government is to the tune of around $120 million. They delay in decision making is unfathomable. It appears that the decision makers simply do not understand the market dynamics.

Even the long-term deal with Qatar at 10.2% of Brent for up to four cargoes per month was recommended but not accepted, due to bureaucratic bottlenecks. Fortunately, the government has finally given a green signal to long-term contracts around 11-11.5% of Brent.

Another problem is of natural gas and power companies which do not give demand at right time. Rigid procurement rules also fuel these inefficiencies. It is best to leave the decision making to the private sector.

Oil prices are flirting over $70/barrel and the forecast is of a further increase. That is to put strain on imports as petroleum products’ consumption is growing. The government is not passing on the price impact to consumers and losing on improved PL collection in the process. Increasing PL and consumer prices may be a first tough decision, but the government must take it for continuation of the IMF programme.

Then there is another problem of mounting fiscal deficit. PL target is of Rs610 billion, and the government must target meeting half of it by passing the impact to consumers. Power sector subsidies are bound to grow due to expensive fuel. At current RLNG spot rates, it is better to run old furnace oil or diesel plants. Some of these are already operational. The government must choose between whether to offer subsidy on power or on petroleum.

Moreover, fiscal slippages will also increase due to provincial surpluses, as the numbers are not adding up. FBR tax revenues may also fall short by a couple of hundred billion rupees. A cutback in development budget is likely. Public sector expertise lies in building roads and bridges, while the country has enough roads with low traffic load. Sacrificing development spending would ease some pressure on balance of payment, while pickup in private sector activity shall be sufficient to attain next year’s GDP growth target.

Bottom line is that macro stresses are building, but no immediate crisis is so far in the making. The important element is to tread with care and not to get carried away by growth momentum. The Prime Minister needs to think beyond election cycle to ensure transition from stability to sustained growth.

Copyright Business Recorder, 2021