Foreign inflows at a low ebb

International perceptions of the declining credit worthiness of Pakistan have been augmented by the downgrading of the country’s credit rating by S&P, Fitch, and Moody’s from ‘stable’ to ‘negative’. Recently, Moody’s has also taken Pakistan down from B3 to Caa1 rating and so has Fitch. The latter rating is usually given to countries considered as close to default. They include Ghana, Argentina, Nigeria, Angola, El Salvador, etc.

J P Morgan has said a few days ago that the big increase in discount on Pakistani Euro/Sukuk bonds is justified given the big exposure to risk of lending to this country. Now there is an almost a two-thirds discount on Pakistan’s international bonds.

The impact of these negative international assessments of Pakistan, augmented further by the impact of the floods, is a substantial ebbing in inflows into Pakistan. This has happened despite the umbrella provided by a functional IMF (International Monetary Fund program, which is expected to continue till June 2023.

The first and perhaps the clearest indicator of the trend in flow of assistance to the Government is the quantum of inflows from bilaterals and multilateral agencies to Pakistan, from flotation of bonds and borrowing from international commercial banks respectively.

According to the SBP (State Bank of Pakistan), this aggregates to only $2202 million in the first quarter of 2022-23. The federal budget has estimated the requirement at $22 billion for the on-going financial year. Therefore, only 10% of the target has been met in the first quarter.

According to the Federal Budget of 2022-23, the break-up of the expected new inflows, aggregating to $22 billion, are $3 billion from the IMF, $2 billion by flotation of Euro bonds, $7.5 billion of commercial bank loans and $9.5 billion from multilateral agencies and bilaterals.

The amounts received up to and end-September are of $1166 billion from the IMF and $1036 million from other sources. There has been no flotation of bonds or large borrowings from international commercial banks.

The consequence of the drying up of the inflows is that foreign exchange reserves are now down to critically low levels. They have fallen by $2.2 billion since end-June 2022, and now stand at only $7.6 billion. This is enough to provide import cover for only 1.3 months. This persistent decline in foreign exchange reserves will further augment negative perceptions of Pakistan and could lead to more ebbing of inflows.

Turning to the non-debt creating inflows, these have also shown a significant declining trend since June 2022. The first type of such inflows is home remittances. They attained a peak of $32.9 billion in 2021-22, by achieving a growth rate of over 6%. However, they have fallen by 6% in the first quarter of 2022-23, with the drop being larger in September of over 12%.

The view has been presented that there has been a significant diversion of the flow to the Hundi market because the large differential in the rupee exchange rate between the open market rate and the inter-bank rate.

This is validated by the drop in remittances from virtually all sources, including the UK, Saudi Arabia, UAE, other GCC Countries and EU countries. The only source with a positive growth rate is the USA. There is the risk that if the premium in the Hundi market persists official inflows into the banking system will continue to be smaller.

The other non-debt creating inflow is of foreign investment. Here also, there is a big drop. Foreign direct investment in the first quarter has plummeted by 62% to $157 million, in relation to the level in the corresponding period of 2021-22. Similarly, while there was a net inflow of $947 million due to bond flotation in the first quarter of 2021-22, there has actually been a net outflow of $29 million from July to September 2022.

Overall, according to the balance of payments statistics released by the SBP for the 1st quarter of 2022-23, the net overall inflow into the financial account is $382 million, as compared to the vastly larger inflow of $5730 million in the first quarter of 2021-22. Also, the IMF projection was of a gross inflow of $4100 million in this quarter.

Therefore, it is not surprising that despite a 37% smaller current account deficit, the overall balance of payments has gone into a large deficit of $1999 million, as compared to a surplus of $2164 million in the first quarter of 2021-22.

There is no doubt that this drying up of external inflows into Pakistan must be stopped otherwise even if the current account deficit continues to remain low there will still be a hemorrhaging of foreign exchange reserves in the on-going quarter.

Already in the first week of October, reserves have fallen by $303 million, and are now down to a paltry $7.6 billion. A crisis situation will be reached if they fall by, more or less, the same amount as in the first quarter.

What are the prospects for large net inflows? The World Bank and the Asian Development Bank have committed to at the minimum diverting funds from slow moving projects for flood rehabilitation and reconstruction. The ADB has committed to releasing shortly $1.5 billion.

The IMF is undertaking the ninth review in the first week of November. If the review is successful, Pakistan is likely to receive a loan installment of SDRs 894 million, equivalent to approximately $1140 million.

However, there is the likelihood of some key performance criteria not being met like the level of net international reserves, size of the primary deficit, etc., as of end-September. Therefore, unless waivers are obtained especially considering the negative impact of the floods, the funding from the IMF may not be forthcoming or be delayed.

Finally, the Prime Minister is going to China in early November. His agenda will include resumption of funding of CPEC (China Pakistan Economic Corridor) projects and presumably substantial rescheduling of the bilateral debt with China. We hope that the Prime Minister will be able to get substantial support from China.

Overall, the financial situation is very fragile. There cannot be another decline in foreign exchange reserves in coming months and a severe crisis situation must be avoided at all costs.

Copyright Business Recorder, 2022