Major negative developments

The downgrading of Pakistan’s credit rating by Moody’s from B3 to Caa1 comes as a big shock. The credit rating agency has cited increased government liquidity and external vulnerability leading to higher debt sustainability risks, especially following the devastating floods.

Moody’s is also of the view that Pakistan will remain highly reliant on financing from multilateral and bilateral creditors to meet its debt repayments, in the absence of access to market financing at affordable costs. It is indeed worrying that these views have been expressed despite the presence of a functional IMF programme in Pakistan.

Which are the other countries that have been classified in the low Caa-1 category by Moody’s? The list includes Angola, Barbados, Democratic Republic of Congo, Gabon, Iraq, the Maldives, and Tunisia. All these countries are generally considered as highly vulnerable to a default in their external payments.

The Moody’s assessment is not entirely inconsistent with the low and declining foreign exchange reserves of Pakistan. As of last Thursday, the SBP reserves stood at $ 7,900 million. They have fallen by $ 1,916 million since end-June 2022. This is despite the receipt of the loan instalment of $ 1,170 million from the IMF in early September. The implication is that in the first quarter of 2022-23 there has been a large balance of payments deficit of $ 3,086 million. This is in sharp contrast with the surplus of $ 2,164 million in the first quarter of 2021-22.

One of the major reasons for the big deterioration in the balance of payments position is the drying up of inflow of funds from external sources in the first two months of 2022-23. According to the Monthly Disbursement Report of Foreign Economic Assistance for August 2022 of the Ministry of Economic Affairs, the total inflow of funds from bilateral and multi-lateral agencies was a paltry $439 million as compared to the expectation of the total inflow of $ 8,715 million in 2022-23. There has been no flotation of Euro/Sukuk bonds or borrowing from international commercial banks. The total inflow is only 2 percent of the annual targeted requirements of $22,817 million. It is unlikely to have improved in September 2022 given the depletion in foreign exchange reserves during the month. Hopefully, the committed $2.5 billion from the ADB will arrive soon.

One of the performance criteria in the IMF programme for the ninth review is that the level of net international reserves can fall by end-September by up to $666 million. The decline is likely to have been much more in the face of the quantum decline in the gross foreign exchange reserves of the SBP.

There are other developments on various fronts which are also worrying in nature. While there is the good news that the FBR has met the revenue collection target for the first quarter of 2022-23, there have also been some negative outcomes on the budgetary front during this quarter.

First, there is a significant shortfall in revenues from the petroleum levy. The quantum jump in retail prices has led to a large fall in the sales of motor spirit and HSD oil. According to the Oil Companies Advisory Council (OCAC), the sales of these two products have declined by 21 percent and 33 percent, respectively, in the first two months of 2022-23, compared to the sales in the corresponding period of 2021-22. Therefore, if the fall persists then there is likely to be a big shortfall in revenues from the petroleum levy in 2022-23, in the presence of the ambitious annual target of Rs 855 billion.

Second, the provincial governments have generated a cash surplus of Rs 197 billion in the first quarter of 2022-23. This is 21 percent less than the surplus generated in the corresponding quarter of 2021-22. Of course, the level of expenditure has probably increased due to the relief work in the floods. However, the target surplus is of Rs 750 billion in 2022-23, which requires a more than doubling over last year’s level. This now seems very unlikely.

Third, one of the bottom-line indicators of the budgetary position is the level of net bank borrowing by the federal government. It stands at over Rs 256 billion as of the end of September. In sharp contrast, there was actually a retirement of Rs 62 billion debt in the first quarter of 2021-22. The annual target for 2022-23 is a reduction in the level of domestic bank borrowing by the government of 48 percent.

There are other performance criteria and indicative targets for the ninth review relating to the first quarter of 2022-23 which may not be met based on information available. This includes the following:

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Performance Criteria
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4   Ceiling on general government primary budget deficit
4   Ceiling on government guarantees
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Indicative Targets
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4   Ceiling on net accumulation of tax refund arrears
4    Ceiling on power sector payment arrears
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Many of the above targets would have been difficult to meet even in normal circumstances. Now, with the disastrous impact of the floods and other factors they are well-nigh impossible to achieve in 2022-23.

There is need for the government to renegotiate on a priority basis the IMF program reforms and targets for 2022-23 in light of the floods. The country now has a seasoned Finance Minister who has vast experience of dealing with the IMF. The only IMF program fully completed successfully was from 2013 to 2016 during his tenure. We hope that he will be able to repeat his success once again with the IMF.

The risk of interruptions in the IMF programme and a growing shortfall in receipt of external financing in relation to the requirement of $22 billion in 2022-23 are beginning to give sleepless nights. If these uncertainties grow further, then unfortunately the floor may eventually go out of the value of the rupee.

Copyright Business Recorder, 2022