Hiatus with IMF

The news has come from Washington that the IMF has declined the request by our Finance Minister for release of the quarterly installment following the fourth review. Instead, it is now proposed that the Fund will undertake the fifth review shortly of the first quarter of 2014-15. If successfully completed, there will be a combined release of $1.1 billion, following Executive Board approval, in December 2014.
However, there is no guarantee that the fifth review for the quarter, July to September 2014, will be successful. After a relatively strong performance in the last quarter of 2013-14, the economy has begun to unravel in the first quarter of 2014-15.
There has been a big deterioration in the current account deficit in the balance of payments. In July and August, the deficit has increased by 137% compared to the deficit in the first two months of 2013-14. This is primarily due to a worsening of the trade deficit. Exports have fallen by 10% in the first three months, while imports have increased sharply by 12%. Consequently; the trade deficit is higher by $2 billion.
According to projections by the IMF, following the third review, exports and imports were expected to be, more or less, unchanged in relation to the previous year's level. The actual trade deficit is higher by 17% over the projected magnitude. The financial account was expected to show a big surplus of about $1.2 billion in the first two months. Instead, the actual surplus is 63% smaller. This is primarily due to large short fall of 84% in net inflows of foreign direct investment.
Overall, according to the IMF projections, foreign exchange reserves were expected to rise from $9.1 billion at end of June 2014 to $10.3 billion by the end of September 2014, but they have actually fallen by $486 million. The decline would have been larger but for some privatization receipts, a CSF tranche and a quarterly release by the IMF at the start of 2014-15.
The position with regard to public finances is no better. FBR has closed the first quarter with a modest increase in tax revenues of 13 %. There has been a shortfall of Rs 40 billion in relation to the target agreed with the IMF. Gas Infrastructure Development Cess (GIDC) is in jeopardy following its dismissal by the courts. The tariff differential subsidy in the power sector will be substantially larger in the absence of an escalation in tariffs. Circular debt of over Rs 250 billion is also to be retired. The floods and the IDPs will necessitate substantial relief and rehabilitation costs. The federal PSDP has been cut by Rs 40 billion in the first quarter. Already, it seems that the fiscal deficit reduction to 4.9% of the GDP is infeasible and it could rise significantly close to the level attained in 2013-14.
Given this performance in the first quarter, it is possible that most of the quantitative performance criteria may not be met. Net international reserves were expected to rise by $1.2 billion, instead they have fallen. Borrowings from SBP were required to fall by Rs 170 billion. The actual fall is much smaller at only Rs 11 billion. Total fiscal deficit was set at Rs 376 billion, as one of the performance criteria. However, it is likely to be larger. Further, privatization receipts were expected to finance a significant part of the deficit. This has not happened. A decision on the sale of OGDC's shares is awaited from the Supreme Court.
Given the strained relationship with the IMF following the fourth review and the fact that the economy has gone off-track again, it is possible that the fifth review will not be successfully completed after the mission by IMF staff. Therefore, what is likely to happen?
The Fund may ask for some major prior actions before agreement can be reached on the release of the combined installment of $1.1 billion. First, a significant depreciation of the rupee may be demanded. In retrospect, the substantial revaluation of the currency in early 2014 appears to have been a big blunder. Second, to compensate for the revenue shortfall, the Fund may insist on the presentation of a mini-budget. This could include withdrawal of all remaining SROs in customs duty and sales tax. Third, a big escalation in gas prices and in electricity tariffs may also be asked for. These actions have been committed to by the government in the Letter of Intent of June 19, 2014.
The fundamental question is whether the Government, which is beleaguered on the political front, can make such big moves at this time. If not, then the likelihood is that the EFF with the IMF may for all practical purposes come to an end. It will then be difficult to fill the external financing gap of almost $11 billion. This would be a tragedy as the country is already mired in a war with almost one million IDPs and there have been devastating floods. The big failure is the inability of the government to get more support from the international community at this difficult time. A worsening of economic conditions could add to the political turmoil in the country. Therefore, a contingency plan must be prepared of home-grown measures and kept as a back up option.
(The writer is the Managing Director of the Institute of Policy Reforms (IPR) and a former federal minister)