Early warning signs

The first quarter of 2023-24 is about to come to an end. It has been an eventful quarter. It started well with the finalization of the Stand-By Facility (SBF) by the IMF (International Monetary Fund) of $3 billion. There was a release soon after of the first installment of the loan of $1.2 billion.

Simultaneously, deposits were received of $3 billion from the Middle East. Consequently, the level of foreign exchange reserves increased to $8.7 billion in mid-July, thereby eliminating the possibility of any short-term problems in external payments.

The nine-month SBF seeks a strong process of stabilization of the economy. The IMF staff document contains the macroeconomic projections for 2023-24 and the quarterly targets, performance criteria and structural benchmarks for September and December 2023. Many of these are ambitious and demanding in character.

The IMF expectation is that the GDP growth rate will be 2.5% in 2023-24. Private investment is expected to show a strong recovery with an increase in real terms of 38%. The rate of inflation is projected at a monthly average of 25.9%, with the rate declining sharply to 16.2% by June 2024.

Based on the withdrawal of all physical restrictions on imports which were operative last year, the IMF has projected an increase in imports of 20% in 2023-24. However, the current account deficit is expected to remain at a moderate level of $6.5 billion, due to a significant jump in exports and remittances. Foreign exchange reserves are projected to reach $9 billion by end-June 2024, thereby leading to a more than doubling in relation to the level in end-June 2023.

The budgetary position is also expected to improve substantially in 2023-24, due primarily to a big upsurge in both tax and non-tax revenues of 31% and 63% respectively. This will enable the financing of the hump in debt servicing of over 25%, due to the very high level of interest rates, and still generate a primary surplus of close to 0.5% of the GDP, perhaps for the first time.

The early developments on the macroeconomic front in the first quarter of 2023-24 are beginning to raise some doubts about the veracity of the IMF projections for the full year.

The GDP growth rate will hinge especially on recovery of the large-scale manufacturing sector which shrank by 10% last year and by 15% in June 2023. Fortunately, the prospects for the agricultural sector look better with a bumper cotton crop.

The source of worry is the contraction in bank credit to the private sector by Rs 223 billion as of the 1st of September. Clearly, the extremely high interest rates are impacting severely on private investment. The likelihood of a 38% jump in private investment, as per the IMF projection, is very low.

The rate of inflation has also been sticky downwards. It has declined by 0.9% points in July and by 2% points in August in relation to the 29.4% rate of inflation in June.

The lumpy increases in electricity and gas tariffs and in POL prices are exerting a strong pressure on the price level. Here again, the IMF expectation that the rate of inflation will drop sharply by June 2024 to 16.2% appears to be very optimistic. In fact, the inflation rate could rise in September 2023 due to a low-base effect.

The rate of inflation is also linked to the rate of depreciation of the Pakistani rupee. The IMF has projected that the value of the rupee with respect to the US$ will fall by 20.4% in 2023-24. Despite recent attempts at managing the open market, the inter-bank exchange rate has declined by almost 4% in the first ten weeks of 2023-24.

At this rate, the annual depreciation could approach 20%, especially if the market-based exchange rate policy is expected to contain imports at a level whereby financing can take place without putting pressure on the foreign exchange reserves.

The worrying development is a severe contraction in the inflows of workers’ remittances by as much as 21.6% in the first two months of 2023-24. This is in sharp contrast to the IMF projection of an almost 22% increase in 2023-24. Hopefully, the virtual elimination of the difference between the open-market and inter-bank exchange rate will increase inflows through banking channels.

Exports have also declined in July and August by over 8%, in contrast to the IMF export growth projection of almost 19%. There is the risk now that if imports maintain an upward trend, then the current account deficit in 2023-24 will be higher than the target in the SBF of $6.5 billion.

Already, the current account deficit was close to $1 billion in the first two months. The financial account in the balance of payments was only marginally positive in August. In fact, there was a negative inflow into the government account in August. The foreign exchange reserves are down to $7.7 billion, significantly below the target for the end of the year of $9 billion.

Turning to developments on the budgetary front, there is apparently the good news that FBR has met the revenue target for July and August.

The growth rate achieved is 26%. With the rate of inflation at close to 28% during these two months, the implication is that revenues have actually fallen in real terms. The required growth rate in FBR revenues during the remaining ten months of 2023-24 is almost 32%. This will require an acceleration in the growth rate from that achieved in the first two months, especially with a larger import tax base.

There are other budgetary targets, which may be difficult to achieve in 2023-24, based on recent trends. First, the annual target for the provincial cash surplus is Rs 600 billion. As of the 1st of September 2023, there is actually a Rs85 billion deficit. Second, petroleum sales are being affected by the rising prices and achieving a 60% growth in revenues from the Petroleum levy looks unlikely. Third, State Bank of Pakistan profits are growing at a smaller rate than the required increase of a trebling of revenues in 2023-24.

Overall, there are major early warning signs.

The IMF Macroeconomic Projections are beginning to look unattainable, especially those related to the rate of inflation, the external balance of payments and the budget deficit. Strong corrective actions by the caretaker government will be required to ensure that the first performance review in November 2023 of the SBF is successfully completed. There is need for the caretaker government to focus especially on achievement of the following performance criteria and indicative targets for September 2023:

• Floor on Net International Reserves

• Floor on FBR Revenues

• Ceiling on Primary Budget Deficit

• Ceiling on Government Guarantees

• Ceiling on Power Sector Payment Arrears.

Copyright Business Recorder, 2023