There’s a need for belt-tightening measures

To market participants’ surprise, SBP (State Bank of Pakistan) has increased the policy rate by one percent (100 basis points) to 16 percent. Although some market participants were not expecting a major hike, economic indicators– inflation, external and fiscal —show that a hike was doctor’s prescription.

Some players were expecting that incumbent finance minister Ishaq Dar would not allow further monetary tightening. However, those players have been proven wrong. It appears that the government is keen to return to the IMF (International Monetary Fund). Secondly, external imbalances have SBP more worried than what analyst community generally had in mind.

On the face of it, SBP has described rising inflation as its primary concern. No doubt, inflation refuses to tame down, and core inflation is rising as well. Medium-term outlook of 5-7 percent is nowhere in sight with the fiscal year forecast having increased to 21-23 percent. And for higher inflation to not remain entrenched, SBP has decided to remain hawkish.

However, reading between the lines, SBP is more worried about exchange rate stability and external account vulnerabilities. And to counter it, monetary policy has been further tightened. The problem is that despite current account coming under control, external risks have not subsided. This is even though extreme measures have been taken to contract imports, which are significantly down now, current account is still not in surplus. That is due to falling exports and remittances. SBP must do more to manage the imbalances.

The problem is that SBP is doing selective tightening. Administrative measures have been taken to control certain imports. But at the same time, travel remains open and leakages have not been plugged. There has been some belt-tightening by the private sector due to high inflation and falling real incomes. However, there is no austerity in place on the fiscal side. External account slippages are reflection of the fiscal side. Not enough has been done to curtail expenditure or to increase revenues. The informal economy keeps growing and belt- tightening is not the primary driver. For that, austerity measures such as early closure of shopping malls and shortened working weeks are warranted. Public gatherings (including weddings) need to be restricted. And gas prices must be revised upwards massively.

The incumbents have so far failed to take much- needed administrative measures nor have they imposed new fiscal taxes, showing serious lack of political courage. The finance minister appears to be in a state of denial. He has not paid any heed to growing risks of default. He is adamant on bringing rupee-dollar parity to below 200 even though the gap between the interbank and open market is sharply growing. This has reduced formal inflow of remittances and exporters are holding back dollars due to anticipation of falling Pak Rupee.

All this is happening against the backdrop of falling foreign exchange reserves. And it is hard to bridge the financing gap. It seems that SBP and the government have realised that the reduction in the current account and fall in imports are not enough to resolve external woes. The financing gap is huge – mainly due to debt repayment. Planned financing has not materialized. The IMF review is being delayed once again. More is required to deal with the chaos.

That is why SBP has increased the interest rates. And in the absence of the IMF, expect more rate hikes and further currency depreciation.

SBP should let the currency gap between the interbank and open market bridge. That is imperative in order to fully restore formal remittances and improve exports flows. And at the same time, austerity measures are required to curb demand beyond current administrative measures. SBP must work towards bringing the current account in surplus. There is no other choice.

However, all these measures are still not enough, as the external debt rerolling and fresh financing are nowhere in sight. The financing need is higher for this year and for the coming 2-3 years. Global conditions are not favorable due to higher interest rates and Pakistan’s growing default risk.

All roads are leading towards debt restructuring. Out of $100 billion external public debt, around $90 billion is bilateral, multilateral, and commercial creditors. Multilateral is concessional and long term. It cannot be rescheduled. The key is to look at bilateral debt – mainly by China and GCC friends. And even commercial debt is by banks of these countries where the government has influence. The need is to sit with China and come up with a rescheduling plan. And to do more for Saudi Arabia and other GCC friends to help.

There were political hurdles. For such negotiations to take place, political stability at home is imperative. One big roadblock is crossed. The new army chief is appointed for (at least) three years. Now PTI (Pakistan Tehreek-e-Insaf) and PDM (Pakistan Democratic Movement) should sit together and plan to bring fiscal house in order. First thing for Dar is to bring IMF back on board. For that to happen, expect a mini-budget in December and once IMF programme is resumed, talks with China and Saudi Arabia can move forward for debt restructuring.

All these could and would happen only if the business elite and political, bureaucratic, and military establishment are prepared to work on structural fiscal issues which feed into the external account. And for that taxing real estate, traders and others is required. For now, administrative measures are required for belt tightening. Otherwise, there is no other way to arrest the economic slide.

Copyright Business Recorder, 2022