A frank response

The IMF Mission Leader to Pakistan, Jeffrey Franks, has written an article in Dawn of 15th April 2015. The article is aptly titled, 'On the right track?'. Franks says that the IMF commends Pakistan for its progress in addressing its economic problem during the one and half years that the IMF extended fund facility to Pakistan has been in operation. He does mention, however, that some commentators argue that things are bad and getting worse. He asks the question why there is such a mismatch in views?
The objective of this article is to examine the veracity of each positive statement made by Franks about Pakistan's progress in 2013-14 and up to the end of first half of 2014-15. Following the completion of the last (sixth) review the mid-point of the Program has been reached.
The first point is that an economic crisis has been avoided. This is, no doubt, true. Countries only go to the IMF, which is the global lender of last resort, when they are already in a financial crisis or face an incipient crisis. The presence of the IMF not only provides emergency balance of payments support to the country but also helps in stabilisation of the economy by convincing the country to undertake appropriate prior actions which help in restoring some market confidence. Similarly, Pakistan was promised a funding of $6.6 billion spread over three years. It also undertook some key prior reforms before the first installment was released by the IMF.
Franks then highlights that monetary and foreign exchange performance has improved. Foreign exchange reserves reached $9 billion by June 2014. They are currently at over $11 billion and are expected to cross $15 billion by June 2015. But he forgets to mention how this has happened. Under the umbrella of the IMF, Pakistan has gone on an external borrowing spree. It has floated high cost Eurobonds of $2 billion, more recently an Ijara-Sukuk bond issue of $1 billion and $1.5 billion net credit from the IMF this year. Pakistan also received a large gift of $1.5 billion from a friendly country. Overall, the net increase in external debt is almost $5 billion, more or less, in line with the increase in reserves. This is not a sustainable strategy if Pakistan is to avoid falling into the 'debt trap'.
Unfortunately, the build-up of reserves has not been the consequence of an improvement in the export performance. Despite the granting of GSP plus status to Pakistan by the EU in January 2014, exports grew by only 1% in 2013-14, as compared to the IMF projection of 6% growth. They are falling sharply in 2014-15. According to the PBS, the decline over the last two months has been over 12%. Franks largely blames the poor performance of exports to an 'overvalued exchange rate'. Clearly, the Fund has been unable to advise the SBP to follow a more rational exchange rate policy.
Also, non-debt creating capital inflows have been very small. During the first eight months of 2014-16, foreign direct investment is stagnant at a low level. In fact, the financial account of the balance of payments has turned negative in March 2015. Also, there has been an exodus recently of foreign portfolio money. The presence of a Fund program has not been enough to bolster confidence of foreign investors in the presence of political instability and a difficult security situation.
Franks highlights the fact that inflation has declined sharply and should remain low due to the prudent monetary stance. In the first year of the Program the rate of inflation remained high at 8.6% due particularly to a big escalation in power tariffs and a hike in tax rates. It is only after September 2014 that the rate has fallen sharply by over 6 percentage points to 2.5% in March 2015. But this is not due to any prudent monetary stance but fundamentally due to the precipitous decline in international commodity prices, especially of oil. In fact, the 'core' rate of inflation remains relatively high at 6%, indicating that underlying demand pressures persist in the economy.
The monetary policy advocated by the Fund and adopted with unusual vigor by the SBP has led to 'crowding out' of the private sector. While borrowings from the SBP by the Government have fallen sharply, borrowings from scheduled banks have reached the record level of Rs 1214 billion by 3rd April 2015, more than four times the level on the corresponding date of last year. Consequently, credit to the private sector has fallen by 36%.
It is interesting that no mention is made in the article of the trends in investment in the economy. Despite the apparent macroeconomic stability provided by the Program, investment has failed to revive. The fixed investment rate plummeted to 12.4% of the GDP in 2013-14, perhaps the lowest rate ever. Private investment has declined to below 9% of the GDP. This indicates that the underlying growth potential remains low.
However, Franks is of the view that GDP growth will be around 4% this year. Last year, the growth rate was overstated at 4.1%. In the revised estimates it will probably be between 3.6 to 3.8%. The likelihood that the growth rate will be higher this year looks low, because the large-scale manufacturing sector is performing poorly. In the first eight months the growth rate achieved is only 2% as compared to over 5% in the corresponding period of last year. Agriculture may do somewhat better despite the floods in Punjab. But a growth rate of 4% or more of the GDP in 2014-15 will definitely come as a pleasant surprise.
Turning to public finances, Franks is clearly very pleased about the developments on this front during the tenure of the Program up-till now. In particular, he highlights the fact that tax revenues have increased by 0.5% of the GDP last year and are on the track to rise by more than 0.5% of the GDP this year. The increase in 2013-14 is in relation to 2012-13, which was an election year and a number of concessions were granted by the PPP government. Therefore, 2012-13 is not a representative year. With respect to 2011-12 the increase is only 0.1% of the GDP.
FBR revenues are not performing well in 2014-15, despite the withdrawal of some SROs and increased coverage with higher rates of advance income taxes. Already, the revenue target has been reduced two times, first from Rs 2810 billion to Rs 2756 billion and then to Rs 2691 billion. The growth rate in the first eight months is 13% and in the last three months only 10%. If this growth performance does not improve in the next four months then FBR revenues will reach about Rs 2560 billion, a shortfall of Rs 250 billion in relation to the original target. The prospect is for little change in the tax-to-GDP ratio. More importantly, the overall revenue-to-GDP ratio is expected to drop by 1% of the GDP in 2014-15, due to substantially lower non-tax revenues.
Franks has also eulogised the reforms in the energy sector. He claims that energy subsidies have fallen from 2% of the GDP to 0.7% of the GDP. These subsidies were 1.5% of the GDP in 2012-13, the year prior to the commencement of the Fund program. In 2013-14, they fell to 1% of the GDP and are projected at 0.7% of the GDP in 2014-15. The basic problem is that there is significant underprovisioning of the tariff differential subsidy and this is a major factor contributing to the build up of circular debt. Further, due to liquidity problems in payment for furnace oil imports, power generation has been declining since October 2014.
A claim is also made that energy reforms are reducing losses. This is factually incorrect. According to the State of the Industry Report of Nepra for 2013-14, transmission and distribution losses have remained unchanged at 18.5%, while billing losses have also shown no decline at 11%. A matter of great concern is the big increase of 25% in arrears in payment of bills from Rs 411 billion to Rs 513 billion. There is no evidence yet of improved management of the power sector.
Franks says that the privatisation programme has been reactivated, albeit slowly. Unfortunately, the emphasis has not been on restructuring and subsequently privatising loss-making enterprises. Instead, the easy path of selling shares of profit-making companies has been adopted. Already shares of UBL and PPL have been sold largely to foreign investors. A big transaction in HBL shares is impending. The future stream of dividends and of capital gains of these companies is being sacrificed.
Finally, it is stated that ongoing trade reforms will make Pakistan a better place to do business. This does not appear to be the case yet. The 2014 ranking of Pakistan in the Ease of Doing Business Index of the World Bank/ IFC is 128 out of 189 countries. It has fallen sharply from 110 in 2013.
Overall, Franks' question as to whether Pakistan is on the right track has to be answered with the statement that the key structural reforms for higher and more sustainable growth have yet to take place. Perhaps his positive assessment of performance is motivated by the fact that he is taking up another assignment. Therefore, it is not surprising that he wants to declare victory and move on. We wish him well in his new position in Europe, which will, no doubt, be full of even greater challenges. We also thank him for ensuring a sympathetic attitude of the IMF towards Pakistan.
(The writer is Managing Director of the Institute of Policy Reforms and former Federal Minister)