Challenge of weak external position

In its latest report titled "South Asia Economic Focus", the World Bank has identified weak external position as the most pressing short-term economic challenge for Pakistan. It has noted that while current account deficit remained small due to a marginal improvement in export growth, deceleration in imports associated with economic slowdown and inflows of workers' remittances, falling financial inflows and substantial debt amortisation payments have resulted in a marked drawdown of foreign reserves. In terms of import coverage, reserves declined from about 2.7 months in June, 2012 to 1.5 months by June, 2013 and further to 1.2 months in September, 2013. The Report has also warned that Pakistan "will not be able to recover without major structural reforms, especially in tax administration and the energy sector" but acknowledged simultaneously that the FBR has tried to register tax evaders, remove zero ratings for domestic sales of selected export products and raised excise duty on tobacco, but with little success, as the tax ratio fell to 9.6 percent of GDP during 2012-13. On the energy front, government balked again at increasing power tariff and, as a result, expenditures on the tariff differential subsidy reached Rs 349 billion during FY13 or 1.5 percent of GDP. Meanwhile, the financial losses of state-owned enterprises bled the budget. Fiscal consolidation in the coming months, however, would have a contractionary impact on the economy as its impact would fall disproportionately on public investment but it would enhance general investor perception about the economy and government performance in the medium-term. Indeed, if reforms are adopted and implemented, this would also contribute to keeping the inflation low, thereby improving the investment climate. Besides economic problems, the country also faces many other crises like energy shortages and terrorism.
As is obvious, the report of the World Bank was mainly based on the developments during FY13 and forecasts for 2013-14. Unfortunately, the prognosis of the World Bank continues to be true and highly relevant during the current year, particularly with regard to the external sector of the country. The most worrying aspect or the challenge as identified by the World Bank is that foreign exchange reserves held by the State Bank have tumbled to only dollar 3.95 billion during the week ended on 4th October, enough to cover less than a month of imports, despite an increase of 9.14 percent in home remittances and narrowing of trade deficit by 5.15 percent in the first quarter of FY14. At this level, the central bank's forex holdings are the lowest since 2008 when reserves had dipped down to dollar 3.5 billion and Pakistan had to sign SBA worth dollar 7.6 billion with the IMF to overcome its severe balance of payments difficulties. The crisis now unfolding seems to be more serious than at that time as foreign payment obligations including to the IMF are much higher and chances of the country receiving expected payments from the US in the form of CSF are unlikely to materialise soon due to the political stand-off on debt ceiling and the Federal Government shutdown. Thankfully, Pakistan has again negotiated the Extended Fund Facility with the IMF and also cleared the way for the release of its second tranche but the amount to be released at the end of each review is comparatively very small and probably would be inadequate to meet the foreign exchange reserve targets if other components of the balance of payments including foreign inflows do not show a considerable improvement. The diminishing foreign exchange reserves coupled with the reluctance of the IMF to continue with the EFF programme at some point of time if conditionalities are not met in letter and spirit could create panic in the foreign exchange market, further depreciating the Pak rupee against other currencies. Under the circumstances, therefore, it is very essential to somehow improve the country's current account position and continue with the present IMF programme in order to avoid default on foreign payments and stabilise the rupee rate. The current EFF programme, as was to be expected, depends critically on a very ambitious fiscal adjustment plan which the government is obligated to undertake. There is probably no need to highlight the difficulties likely to be faced in the implementation of the reform agenda agreed with the Fund but its faithful implementation is necessary for fiscal consolidation and avoidance of balance of payments crisis which are prerequisites for regaining strong and sustained growth rates. The country is of course at the crossroads and any misjudgment could be hazardous at this juncture. We say this because some of the measures announced in the previous budget were not only anti-saving and anti-investment but definitely also discriminated against the existing taxpayers. The government, therefore, needs to be more careful in designing and implementing the micro elements of the reform agenda.