The optimism of SBP

The recent statement by the Monetary Policy Committee of the SBP (State Bank of Pakistan) has certainly provided comfort to a reader. Amidst all the bad news of fall in international credit ratings of Pakistan, loss of dollar 30 billion to the economy due to the devastation caused by the floods and of reserves falling to a critically low level, it was indeed reassuring to read the following in the Monetary Policy Statement:

‘Given secured external financial and additional commitments in the wake of the floods, FX reserves should improve through the course of the year’

The basic question is that if enough external financing had been ensured then why is the Prime Minister making hectic visits to Saudi Arabia and China? Why has the Ministry of Finance failed to convince credit-rating agencies like Moody’s and Fitch that Pakistan’s foreign exchange reserves will henceforth be on the upward path after falling by dollar 2.2 billion between end-June and early-October. This happened despite the resumption of the Fund programme and receipt of dollar 1.2 billion from the IMF (International Monetary Fund).

The MPC also appears to be confident that the current account deficit will remain under control throughout the year and adhere to the SBP target of 3 percent of the GDP for 2022-23. The statement says the following:

‘Impact on the current account deficit is likely to be muted, with pressures from higher food and cotton imports and lower textile exports largely offset by slower domestic demand and lower global commodity prices’

The SBP’s target for the current account deficit in 2022-23 at 3 percent of the GDP is somewhat higher than the target in the IMF programme of 2.5 percent of the GDP. Further, the SBP appears to be optimistic about the prospect for lower global prices during 2022-23.

The single most import international commodity price is that of crude oil. Following the cut in volume of exports by OPEC of two million barrels a day, the price of brent (crude) has tended to stabilize at between dollar 92 and dollar 95 per barrel. As the Chinese economy recovers and global demand increases the price could approach dollar 100 per barrel. The price a year ago in October 21 was significantly lower at dollar 84 per barrel.

The other matter of concern is that because of the damage caused by the floods, the output of cotton is down to 6 million bales only. The annual requirement is close to 13 million bales to sustain the textile industry. Therefore, the import of cotton will have to be 7 million bales as compared to 4.7 million bales last year. This will increase the import bill by almost dollar 1 billion. Similarly, the wheat import bill could also be up by over dollar 1 billion.

On the export side, the fall in exports of rice and textiles could exceed dollar 4.0 billion. The decline in the GDP growth rate will reduce the volume of imports by about 3.5 percent equivalent to a drop of dollar 2.5 billion. Overall, the impact of the floods on the trade deficit could be an increase of dollar 3.5 billion. The current account deficit is likely to approach 4 percent of the GDP, with the implied increase in external financing requirements of dollar 3.5 billion.

Turning to the fiscal position, the Monetary Policy Statement states that in the first month of 2022-23, ‘the fiscal deficit fell to 0.3 percent of the GDP and the primary balance recorded a surplus of 0.2 percent of the GDP’. Now the debt figures up to August have been released by the SBP. Accordingly, the derived estimate of the deficit is close to 0.9 percent of the GDP. At this rate it could approach 5.5 percent of the GDP in 2022-23. This is significantly above the target agreed with the IMF of 4.9 percent of the GDP.

The achievement of the target of the first quarter by FBR has also been highlighted with revenues higher by Rs 27 billion. However, this is due to the holding back of tax arrears by almost Rs 80 billion. Also, the growth rate achieved is 17 percent, whereas the annual growth target is 22 percent. This higher growth rate will become increasingly difficult to achieve as this year progresses because of the big fall likely in the GDP growth rate.

The revenue gap is already large in non-tax revenues because of the big shortfall in revenues from the petroleum levy, due to the big contraction in demand following the near doubling of prices of HSD oil and motor spirit. The agreement with the IMF is that in the event of a shortfall, the sales tax will be reintroduced on petroleum products.

This alone will add another 2 to 3 percentage points to the rate of inflation. As such, here again the Monetary Policy Statement states that ‘headline inflation is still projected to gradually decline through the rest of the fiscal year’. This will also depend on the path followed by the exchange rate during the remaining eight months of 2022-23.

The Monetary Policy Statement also highlights the successful completion of the 7th and 8th review under the ongoing IMF programme and the release of a tranche of dollar 1.2 billion. The 9th review is due shortly. Among the various performance criteria and indicative targets for the first quarter of 2022-23, it is likely that some of these may not be met, including the floor on net international reserves, ceiling on the primary budget deficit and ceiling on power sector payment arrears.

The visit of the Finance team to Washington during the IMF General Meeting was probably motivated by the desire to seek a relaxation of some of the Program targets in view of the large negative impact of the floods. We hope that when the IMF team visits Pakistan for the 9th review, it will show a more ‘human face’.

However, there is the likelihood that some actions may be asked as a pre-condition for completion of review. As highlighted above, this could include significant additional taxation. The ability to do this may be limited by the political confrontation in the country today.

A delay in completion of the review by the IMF is likely to lead to a drying up of foreign inflows into the country and imply the lack of any increase or even a fall in reserves. Is the SBP prepared for this eventuality?

Copyright Business Recorder, 2022