External financing requirements

This article is in response to the well-documented and well-written article on Ensuring External Stability by the Deputy Governor of the SBP in a recent issue of this newspaper.

He initially concedes that the widening of the trade and current account deficits has been somewhat faster and larger than initially anticipated. However, he believes that unlike previous such episodes, this one will be manageable.

The rise in the current account deficit from July to October 2021 is attributed 60 percent to the sharp jump in global commodity prices and shipping charges. However, he highlights the existence of cyclicality in commodity prices. As such, the expectation is that they are likely to start coming down during the rest of the financial year. This has already happened with the oil price falling amid concerns about the new Covid-19 variant, Omicron. Also, improved agricultural production in the country will reduce the demand for food imports.

The article also highlights the proactive policy response and the fall in the exchange rate of 12 percent since June in helping to moderate external pressures. The policy rate has also been raised cumulatively by 175 basis points. Also, consumer finance is being curbed through tighter macro prudential regulations.

The Deputy Governor indicates that today Pakistan has healthy foreign exchange reserves and a fully-financed external position. All told, he expects the current account deficit to be close to 4 percent of the GDP in FY-22. Consequently, the external financing requirement, which is the sum of the current account deficit and total external debt repayment, will be around $26 billion in this fiscal year. Apparently, available sources of external financing are more than adequate to meet this external financing requirement while keeping foreign exchange reserves at adequate levels throughout 2021-22.

The article by the Deputy Governor borders on optimism for reasons given below.

There is the issue of the short-run cyclicality in international commodity prices. The crude oil price did drop in the last week of November after the WHO (World Health Organization) announcement of Omicron by almost 15 percent. However, it has since recovered by 8 percent. Such a big drop is not visible in the other major commodities imported by Pakistan. Figure 1 gives the percentage change in these commodities in November 2021.

Therefore, there is the likelihood that high prices will persist for the better part of 2021-22. Historically, the period from the peak to the trough in commodity prices has been two to three years. As such, the pressure on the trade and current account deficits will continue.

In fact, the trade deficit reached an all-time monthly peak in November 2021 of $5 billion. This is 134 percent more than the deficit in November 2020 and 27 percent more than the already high deficit in October 2021. Over the period from July to November 2021 the increase in imports is 69 percent in comparison with the level in the corresponding period of 2020.

The current account deficit has climbed to $5.1 billion in the first four months of 2021-22. Now with the exceptionally large deficit in November it is likely to have exceeded $7.1 billion. At this rate, the projected annual deficit in 2021-22 is likely to reach 5.5 percent of the GDP. Therefore, if the SBP target of 4 percent of the GDP is to be attained than strong stabilization efforts will be required throughout the year. In effect, the average monthly current account deficit from December 21 to June 22 will have to be curtailed by as much as 40 percent in relation to the average monthly level in the first five months of 2021-22.

Therefore, instead of hoping for a precipitate fall in commodity prices in the short run, the SBP needs to focus on the type and intensity of policy instruments to be used for the rest of 2021-22 to limit the current account deficit to 4 percent of GDP for the full year.

The Deputy Governor has highlighted the healthy foreign exchange reserves currently, which have risen to almost $19 billion following the receipt of Saudi funds. But this is the consequence of a large outstanding IMF (International Monetary Fund) loan and build-up of liabilities which have together accumulated to $21.7 billion. Therefore, Pakistan today has negative net international reserves. As the time comes to meet these liabilities the foreign exchange reserve position will deteriorate. There is need for a further big build-up of reserves.

As highlighted above, the SBP has based its forecast of external financing needs for 2021-22 on a 4 percent of the GDP current account deficit, equivalent to approximately $13 billion, and external debt repayment also of $13 billion. This latter magnitude assumes rollover of the China SAFE deposit of $4 billion. Overall, the Deputy Governor has indicated that the total external financing requirement for 2021-22 is $26 billion.

There is need to recognize that this is the highest ever external financing requirement, even after some rollover. The last peak was attained in 2017-18 of $24.4 billion. Despite heavy borrowing it was not possible to meet this requirement. Consequently, by the end of 2017-18 foreign exchange reserves had fallen by over $6 billion.

Therefore, there is need for caution in assuming that the external financing requirement of $26 billion will be fully met through external inflows of borrowing and foreign direct investment. Fortunately, $3.2 billion has been received from Saudi Arabia and $2.8 billion from the IMF as a special SDR allocation globally after Covid-19.

However, other inflows from diverse sources have been relatively small from July to October 21. International commercial banks have been accessed only to the extent of $0.9 billion and $1 billion bonds have been floated. The respective targets for 2021-22 are $4.9 billion and $3.5 billion as given in the Federal budget estimates for 2021-22.

Therefore, the estimated financing that has taken place already or arranged for is close to $11 billion. The amount of borrowing required is $15 billion from December 2021 to June 2022. The SBP estimates that an additional $3 billion or so will flow in from the IMF.

This raises a very fundamental question. At this stage is the SBP justified in assuming that the sixth review by the IMF will be successfully completed and the Programme will continue till September 2022? There are, in fact, a series of prior actions which must be implemented which are difficult both politically and administratively. Does the SBP have a contingency plan in the event there is a delay, suspension, or termination of the IMF programme?

Overall, we have placed faith in the ability of SBP to ensure external stability at a time when the external financing requirements are peaking, and more stabilization efforts are required to restrain the current account deficit. The costs of a big fall in foreign exchange reserves on the exchange rate are likely to be very large and need to be avoided with a considerable degree of certainty. Otherwise. There is the risk of high inflation and big loss of growth momentum in the economy.

(The writer is Professor Emeritus at BNU and former Federal Minister)

Copyright Business Recorder, 2021